Exactly how does IUL provide downside protection and upside potential?

[sam816]

I've heard it's basically by playing stock options, but can one generate enough return to keep up with the indexes?

Here is a video by Steve Savant on IUL:



At 4:50 he explains the downside protection, 97% of the cash value is invested in a bond portfolio that returns 3%, which will bring the cash value back to 100% at the end of year; the other 3% of the cash value is allocated for playing stock options, which generates upside returns. The problems is, even the 3% is doubled, the total return is only 6%:

97% x 1.03 + 3% x 2 = 1.06

and how realistic is to double your money by playing stock options even in a good year?

Let alone in a low interest environment, you have to put more than 97% in bonds in order to be back at 100% at the end of year, which means you may not have 3% for stock options.

I have been asked by some people to present IUL products, but my lack of understanding or skepticism in this feature has impeded my ability to sell this product.

 

[scagnt83]

I dont have the time or desire to watch the video. But worrying about how the carrier "makes the sausage" only does so much good.

I doubt that Steve is using exact numbers, its most likely a hypothetical to show the "basics" of how the product is created by the Carrier.

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If you want to get super technical, yes, the IUL as essentially a managed index options strategy.

They buy Bonds to cover Guarantees.
The rest goes to purchase Options on Indexes.

It is impossible to know exactly how much their Bond Portfolios are Yeilding. They trade on the secondary market and can make purchases at institutional levels/rates. So they seldom are getting just a Retail Yield on holdings. The same goes for their Options holdings.

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The biggest question with IUL is "will Caps stay competitive?".

Interest Rates and Carrier Performance will determine future Cap rates, along with future Expenses.

Right now we are at historic lows from a rate perspective. Will we go lower? Who knows. But chances are that sometime in the next 30-40 years they will normalize again (rise). At least according to most economists and market experts.

So in my opinion, assuming a quality carreir with good financials, the chances of Caps being significantly lowered, or Expenses significantly increasing, are fairly minimal.

I have IULs around the 10-year mark and they all still have competitive Caps. Despite a few being lowered slightly over the years. Some carriers do provide Renewal history for Caps if you look hard enough.

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If you are familiar with the issues traditional UL had that was sold in the 70s/80s/early 90s, IUL is kind of in an opposite position.

In the 80s, they assumed interest rates would stay at historical highs. They didnt.

Now, we assume rates will not decrease significantly from the current historical lows.

And the whole industry is hoping they increase at some point in the next 10-20 years. Who knows what will actually happen. But I doubt we will turn our economy into Japan's failed 0% rate model.

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All that being said. I never recommend IUL to be someones one and only means of building wealth or providing a DB.

It should almost always be combined with Term/GUL/WL to some extent.

And any consideration to building Cash Value, should be in addition to a client's other already established wealth-building strategies.

Every financial product has risk of some type. IUL has interest rate risk and carrier performance risk.

 

[VolAgent]

Don't forget, these are options. They give you the right to buy so many shares at a set price. It isn't a matter of the money that was set aside for options growing and wondering how that could double. It is a matter of the options giving you leverage and allowing you to buy so many shares and be in the money to a certain extent.

For instance, if you own 10 options (and generally an option allow you to buy an even lot, 100 shares) with a strike price of $20 and the index is at $30, then you make $10 x 10 options x 100 shares per option, a $10,000 profit before trading costs. If those options each cost $10, then that is a $9,900 profit before trading costs. If they cost $100, then it is a $9,000 profit, etc.

Also as Scagent83 pointed out, insurance companies are buying at institutional prices and on the secondary market. So their yield could easily be higher than you realize.

So even in Steve Savant's example of 3% allocated to options, it still can turn into a substantial upside.

 

[TampaHound]

I've heard it's basically by playing stock options, but can one generate enough return to keep up with the indexes?

Here is a video by Steve Savant on IUL:



At 4:50 he explains the downside protection, 97% of the cash value is invested in a bond portfolio that returns 3%, which will bring the cash value back to 100% at the end of year; the other 3% of the cash value is allocated for playing stock options, which generates upside returns. The problems is, even the 3% is doubled, the total return is only 6%:

97% x 1.03 + 3% x 2 = 1.06

and how realistic is to double your money by playing stock options even in a good year?

Let alone in a low interest environment, you have to put more than 97% in bonds in order to be back at 100% at the end of year, which means you may not have 3% for stock options.

I have been asked by some people to present IUL products, but my lack of understanding or skepticism in this feature has impeded my ability to sell this product.

Thanks for the video. I'll check it out in a minute but the last paragraph rings true with me. If I don't understand it or am skeptical of it, I'm not going to sell it. I'm still learning about them.