Few on this sight seem to understand but everyone has a guess at how IUL's use options . I am posting part of a white paper explanation from the leading insurance producer group in the United States so everyone knows and understands and to stop the speculation.
Traditional IUL
The interest credits of traditional IUL products are based on the return of an underlying benchmark index, such as the S&P 500. For example, the S&P 500 1-year point-to-point index credits interest equal to 100% participation in the net change in the S&P 500 index from the first date to the last date of the benchmark period, subject to a cap and a floor.
To accomplish this S&P 500 index strategy, the insurer invests most of the account value in its general account and the remaining smaller portion in an options strategy, which is usually a combination of buying and selling index options to achieve the desired option payoff amount. The option cost is the net cost of the options strategy; that is, the sum of combined buying and selling of the index options. The option payoff provides the policy interest credits between the floor and the cap. In Example 1, the growth in the amount invested in the general account portfolio provides the account value floor, and the option payoff provides the upside growth, or net policy return.
Example 1
Imagine $100 in an S&P 500 index account. At the beginning of the benchmark period, the insurer allocates $96 to the general account and $4 to purchase the options strategy. Say the S&P 500 price change over the period is 6%. Then, at the end of the benchmark period, the interest credits to the policy are based on the returns of each component.
Traditional IUL Example
