Illustrating Stochastic Returns in IUL.

[Cash]

Does anyone know of an easy and free way to illustrate stochastic returns in an IUL?

 

[DHK]

Sure. It all depends on the company's illustration software.

In Midland National's software, I could show varying returns. I preferred to show 3 years of maximum earnings (especially since caps are much higher than what you're allowed to illustrate) and 2 years of no earnings... and just alternate it throughout the length of the policy. Unfortunately there are some limitations on their product in California, so I won't be selling it.

But not every company allows for varying returns in their illustration software.

BTW, thanks for teaching me a new word. I had to look that one up.

 

[Tahoe Ray]

Does anyone know of an easy and free way to illustrate stochastic returns in an IUL?

I'm surprised (but not really) that this isn't the standard. Varying returns have a huge impact on investment performance, just as they will on an IUL. Taking loans in good or consistent years, life is great! In some down years, not so much (at least when it comes down to a max scenario over 20 years with a participating loan...)

Good on you for searching this out...hopefully, the IUL carriers will adopt what the FIA carriers already have done which is exactly what you're asking for...real returns (and not an average) plugged into their current cap/spread/participation rates.

 

[Cash]

DHK - What does the CAGR end up being with your method? I am just uncomfortable with a determined return when sequence matters so much.

Tahoe Ray - thank you. I read somewhere that FINRA does not allow companies to illustrate stochastis returns on VULs. Some guys try to show it using loans but that seems like a poor way. I am glad IULs carriers are allowed to show variations in yearly returns since no FINRA. I understand that an agent can take advantage of the illustration but geeze it's UL we are talking about, it is meant to be able to do different things.

 

[BNTRS]

If you are plugging in the numbers or using historical data, you are not using a stochastic model. In order to be stochastic you must have randomness that is not biased nor predetermined (if you are trying to randomly think up the numbers, your attempts are considered biased in most probability circles).

There are carriers that allow a look back within their illustration capabilities, Penn Mutual and Allianz come to mind as options here.

If you are looking to evaluate how variations in return affect loans on indexed universal life insurance, you can see our work by clicking the link.

 

[Tahoe Ray]

DHK - What does the CAGR end up being with your method? I am just uncomfortable with a determined return when sequence matters so much.

Tahoe Ray - thank you. I read somewhere that FINRA does not allow companies to illustrate stochastis returns on VULs. Some guys try to show it using loans but that seems like a poor way. I am glad IULs carriers are allowed to show variations in yearly returns since no FINRA. I understand that an agent can take advantage of the illustration but geeze it's UL we are talking about, it is meant to be able to do different things.

I don't wholesale VULs, but I did wholesale VAs for 10 years and they are both regulated by FINRA and the SEC.

While none of these products will follow a true stochastic model (monte carlo-style testing with thousands of outcomes) in their illustrations, the key is that they allow for variations on real returns.

I am looking forward towards a standardized IUL illustration with "best 30, worst 30, and last 30" as part of their illustration. Maybe that is already available but I haven't seen it...I would love to have someone point me in the right direction if it exists.

 

[DHK]

DHK - What does the CAGR end up being with your method? I am just uncomfortable with a determined return when sequence matters so much.

Because you are asking about this, you are clearly above the standard of most agents trying to sell IUL.

CAGR doesn't matter in the illustration. Most agents are trying to predict the future performance of the policy, and that's where you're going wrong with the IUL sale. We don't know what the market will do.

In addition, doing "back-testing" isn't a good idea because the underlying options will have varied costs and affect caps/participation rates over time.

It's probably where most IUL agents are going wrong in selling it. (That's why there's an interest rate limit on what you're allowed to illustrate versus the current year cap. I'm sure universally right now, that the limit is far below the current caps on all policies.) It's also a reason why the industry is looking at IUL illustrations; Insurers Take Aim At IUL Illustrations

This is a different sale than a WL sale. WL has a guaranteed column and a non-guaranteed column based on current dividend rates... which most WL agents say will generally be paid because of their dividend paying history, but may vary over time - they can be less or more than they are illustrated.

IUL is about managing volatility and crediting the positive years to the cash value, and no loss in down years. As long as the underlying index has movement, up and down... your policyholder will profit from that volatility... up to the amount of the current year cap.

If illustrations weren't required, I wouldn't use one. I think they paint the wrong picture and create false expectations of the product. In fact, I'd explain the client that I don't like the "rosy picture" this illustrates because it is simply wrong. There is no investment out there that will pay out 8.5% (or whatever is your max) every year. If there was, everyone would buy it. Plus, if the market has a double-digit return, that isn't being shown either.

What the IUL illustration shows is the surrender schedule (difference from account value and surrender value), models how interest is credited, and whatever else you build-in to your illustration - such as loans, withdrawals, or payments stopping into the policy.

Sell the concept... not the illustration or the "illusion of infinite growth promises".

----------

I learned from Marvin Feldman the rule of 1 to 100: In 1 year, 100% of your illustrations will be wrong.

Help them know WHY they bought... but not exactly WHAT they bought (illustrations).

 

[Tahoe Ray]

Because you are asking about this, you are clearly above the standard of most agents trying to sell IUL.

CAGR doesn't matter in the illustration. Most agents are trying to predict the future performance of the policy, and that's where you're going wrong with the IUL sale. We don't know what the market will do.

In addition, doing "back-testing" isn't a good idea because the underlying options will have varied costs and affect caps/participation rates over time.

It's probably where most IUL agents are going wrong in selling it. (That's why there's an interest rate limit on what you're allowed to illustrate versus the current year cap. I'm sure universally right now, that the limit is far below the current caps on all policies.) It's also a reason why the industry is looking at IUL illustrations; Insurers Take Aim At IUL Illustrations

This is a different sale than a WL sale. WL has a guaranteed column and a non-guaranteed column based on current dividend rates... which most WL agents say will generally be paid because of their dividend paying history, but may vary over time - they can be less or more than they are illustrated.

IUL is about managing volatility and crediting the positive years to the cash value, and no loss in down years. As long as the underlying index has movement, up and down... your policyholder will profit from that volatility... up to the amount of the current year cap.

If illustrations weren't required, I wouldn't use one. I think they paint the wrong picture and create false expectations of the product. In fact, I'd explain the client that I don't like the "rosy picture" this illustrates because it is simply wrong. There is no investment out there that will pay out 8.5% (or whatever is your max) every year. If there was, everyone would buy it. Plus, if the market has a double-digit return, that isn't being shown either.

What the IUL illustration shows is the surrender schedule (difference from account value and surrender value), models how interest is credited, and whatever else you build-in to your illustration - such as loans, withdrawals, or payments stopping into the policy.

Sell the concept... not the illustration or the "illusion of infinite growth promises".

----------

I learned from Marvin Feldman the rule of 1 to 100: In 1 year, 100% of your illustrations will be wrong.

Help them know WHY they bought... but not exactly WHAT they bought (illustrations).

I can't disagree with much of this...however a sophisticated client still wants to see projections of potential results.

This is why I prefer whole life. Most of the clients who can truly fully fund an IUL to the max are already likely overexposed in risky assets. I know that there are a number of people on this board who will disagree with me (and I do sell IUL) but the ability of the carrier to reduce caps and alter expenses at the cost of the policy continue to make me question their viability.

What if the carrier is sold? What if they encounter financial problems? Aviva was a massive seller of IUL for many years so it will be interesting to see what happens with those policies.

I prefer to present off of a legal pad and provide some basic information with an illustration. I told a client on Monday that these illustrations are "illusions" however they are a guide. If you expect 50-75% of what a well-run illustration shows you, the disappointment factor decreases exponentially.

To each their own. The bottom line is whether your client chooses an IUL or a WL plan, you need to be around to manage it. THAT is something that few agents in our business can truly offer.

 

[Cash]

Because you are asking about this, you are clearly above the standard of most agents trying to sell IUL.

CAGR doesn't matter in the illustration. Most agents are trying to predict the future performance of the policy, and that's where you're going wrong with the IUL sale. We don't know what the market will do.

In addition, doing "back-testing" isn't a good idea because the underlying options will have varied costs and affect caps/participation rates over time.

It's probably where most IUL agents are going wrong in selling it. (That's why there's an interest rate limit on what you're allowed to illustrate versus the current year cap. I'm sure universally right now, that the limit is far below the current caps on all policies.) It's also a reason why the industry is looking at IUL illustrations; Insurers Take Aim At IUL Illustrations

This is a different sale than a WL sale. WL has a guaranteed column and a non-guaranteed column based on current dividend rates... which most WL agents say will generally be paid because of their dividend paying history, but may vary over time - they can be less or more than they are illustrated.

IUL is about managing volatility and crediting the positive years to the cash value, and no loss in down years. As long as the underlying index has movement, up and down... your policyholder will profit from that volatility... up to the amount of the current year cap.

If illustrations weren't required, I wouldn't use one. I think they paint the wrong picture and create false expectations of the product. In fact, I'd explain the client that I don't like the "rosy picture" this illustrates because it is simply wrong. There is no investment out there that will pay out 8.5% (or whatever is your max) every year. If there was, everyone would buy it. Plus, if the market has a double-digit return, that isn't being shown either.

What the IUL illustration shows is the surrender schedule (difference from account value and surrender value), models how interest is credited, and whatever else you build-in to your illustration - such as loans, withdrawals, or payments stopping into the policy.

Sell the concept... not the illustration or the "illusion of infinite growth promises".

----------

I learned from Marvin Feldman the rule of 1 to 100: In 1 year, 100% of your illustrations will be wrong.

Help them know WHY they bought... but not exactly WHAT they bought (illustrations).

I agree with selling the concept not the illustration. Of course as Tahoe Ray said prospects want to see them.

Finding the answers is more about me than the prospects however. I want to know what kind of return I am selling within limit. I would love to see a Best 30 worst 30 last 30 like Tahoe Ray suggested and a stochastic return with a percentage given to reach stated goal. Monte Carlo simulations can give an advisor the likely hood that a client will run out of money at a certain age. I want something like that. Maybe I will build it myself and then post it here.

Of course it wouldn't be consumer approved though.

I just came across this from Glenn Daily's website, Glenn S. Daily - Fee-only Insurance Consulting

"In "Policy Illustration Technology: It's All about the ‘Ups' and ‘Downs'," published in the March 2014 issue of the Journal of Financial Service Professionals, Richard M. Weber and Christopher H. Hause modeled an indexed universal life policy to show the disparity between deterministic and stochastic illustrations. The deterministic illustration — what we now have — showed a 100% chance that a $5,417 premium would keep the policy in force for life, assuming an 8% constant interest rate. A stochastic illustration using historical S&P 500 returns (8.45% long-term average, without dividends) with a 0% floor and 13% cap showed that this same premium would keep the policy in force until maturity only 20% of the time. With a 10% cap, failure was almost certain.
Furthermore, if you wanted to rely on a deterministic illustration to estimate the premium that would have only a 10% chance of failure, you would have to reduce the constant interest rate to 5.2% to 6.3%, depending on the assumed cap. So it would take a downward adjustment of 1.7% to 2.8% to get a premium that might be viewed as acceptably risky by the buyer.
Deterministic illustrations are so unreliable for making policy purchase and maintenance decisions that it should be a no-brainer to ban their use and require stochastic illustrations. However, insurance companies and insurance regulators have shown no interest in doing this."

Interesting. So it look likes 6% is a good number. I will see if my library has access to that journal and get the details.

 

[plannerman]

Nice copy and paste. If you truly do this homework you should be working at a company.