Are IUL Multiplier Bonuses Too Risky?
One of the most controversial design elements in modern-day IULs is the Multiplier Bonus. At the moment, the majority of IUL multiplier propositions allow a client to accept an additional asset-based charge in exchange for a multiplier bonus that enhances the index return.
In this arrangement, the client doubles down on the carrier’s ability to buy more options contracts from the investment bankers. Often times, IUL critics accuse IUL Multipliers of being opaque, mysterious, and expensive, however the multiplier proposition is actually quite simple.
As an example, if the multiplier bonus factor is 1.45 X, this means that the after-floor/after-cap index return would be multiplied by 1.45 , giving the pre-multiplier return a 45.00% boost.
15.00% End-Of-Segment S&P 500 Return
> 10.00% IUL Cap .
10.00% End-Of-Segment After-Floor/After-Cap Return
x 1.45 Multiplier Bonus .
14.50% EOY Index Credit After Multiplier Bonus
If the client likes this proposition, they can elect to purchase this feature each year at policy renewal for an asset-based charge. For example, if the asset-based multiplier charge is 1.00%, that means the policy receives an additional charge on top of the standard policy charges, calculated by multiplying 1.00% by the Accumulated Value and deducted from the Accumulated Value in the current year (1/12 of 1.00%, monthly).
Pre-AG-49A, one of the biggest criticisms of these multiplier features was that the carrier illustration depicted a static positive index credit each year, which illustrated a multiplier advantage each year. In other words, if the carrier illustration showed a static 5.50% index return every year, and the multiplier bonus factor was 1.45 X, the illustration’s cash value growth in the illustration was actually calculated based on a 7.98% index credit (5.50% x 1.45 = 7.98%), not the stated 5.50%.
Using the static positive index credits in a carrier’s illustration was misleading because in a real-world scenario, the S&P 500 is going to experience some negative return years wherein the policy’s index credit would be 0.00%. In these years, not only would the policy’s cash value decrease due to the standard policy charges, but the additional 1.00% multiplier asset-based charge would create an additional reduction in cash value.
The IUL multiplier critics and die-hard Whole Life fans accused IUL illustrations of being misleading because the illustrations assumed a positive multiplier bonus each year, not taking into consideration the substantial reduction in cash value the additional asset-based charges could cause during 0.00% index crediting years, and they were right… sort of.
The problem was that no one did the math.
The critics were making broad conceptual assertations that the multiplier propositions were too risky and the asset-based charges too costly, but they had no mathematically-proven analytics to back up their claims.
On the other side of the fence were the over-zealous IUL fanatics that reveled in showing the massively bolstered returns and claimed that IULs with multiplier bonuses were the best thing since sliced bread, but they had no mathematically-proven analytics to back up their claims either.
So who was right?
Neither of them.
As a result, the regulators passed a new actuarial guideline – AG-49A – that restricted carrier illustrations from illustrating multiplier bonuses. The illustrations could now only show multiplier asset-based charges, but no multiplier bonuses. The non-sensical nature of this restriction didn’t solve the problem they were trying to solve.
I would agree that an illustration that depicts a positive static return every year wherein a multiplier bonus enhances the index return every year tells a very incomplete and inaccurate story of how multiplier IULs actually work, but I would also say that showing a carrier illustration with multiplier asset-based charges with no multiplier bonus credits also tells a very inaccurate story.
As a result of the illogical way this restriction was implemented, most agents started running illustrations without any multiplier features. The problem with this decision was that if the client intended to buy an IUL with a multiplier feature, the agent was showing the client something they were not actually going to buy. This is perhaps the most inaccurate scenario of all scenarios an agent could present to a client.
To complicate things even further, if the client was actually going to buy an IUL with a multiplier feature, and they were originally shown an illustration without the multiplier feature, just prior to policy delivery, the client had to sign a version of the illustration that included all the product features they were actually buying, which included the multiplier feature. This meant that the agent had to re-run the illustration and include the multiplier asset-based charges, which then depicted a much worse cash value accumulation outcome because the additional charges eroded the as-illustrated Cash Value with no multiplier bonus enhancement taken into consideration. This version of the illustration looked substantially worse than the first version the client saw when they initially made their decision to buy, which made the agent look like they had bait-and-switched the offering.
As an alternative, the agent could have just started off showing the client a version of the illustration that included all of the multiplier charges (but did not include any of the multiplier benefits), and say, “Trust me, there are multiplier bonuses included, but I can’t show them in the carrier illustration.”
That would be like trying to sell a $550,000 Lamborghini Aventador that actually puts out 770 horsepower, despite the brochure stating that it only puts out 570 horsepower, and telling the client, “Trust me, not the brochure.”
The third option the agent had was to not sell any IULs with multiplier bonus features whatsoever, restricting the client from buying something that might be tremendously beneficial to their overall estate plan, retirement plan, and overall financial plan. Clearly, this was not a good option either.
I am a big supporter of compliance and industry regulation in general, for I believe the spirit of regulated compliance is rooted in consumer protection, and consumer protection is a good thing.
But AG-49A did not solve the problem of lack of transparency in carrier illustrations. It just exchanged one problem for another – exchanging one inaccurate depiction for another inaccurate depiction. The illustrative limitations and inaccuracies that AG-49A created didn’t stop there either.
AG-49A also required the carrier illustration to depict a static Participating Loan Rate equal to 0.50% less than the index crediting rate illustrated, despite what the actual Participating Loan Rate was. In other words, if the carrier illustration assumed a 5.75% index crediting rate, the Participating Loan Rate had to be illustrated at 5.25%, even if the actual Participating Loan Rate was only 5.00%.
This problem was two-fold.
First, this depiction showed a Participating Loan Rate that was not accurate. And second, because the illustration depicted a positive static index credit every year, there was always a positive arbitrage between the index credit and the Participating Loan Rate, which will not happen in years when the actual Index Credit is lower than the actual Participating Loan Rate.
In a year wherein the Participating Loan Rate was 5.00% and the index credit was 2.00%, the client would actually lose 3.00% in that negative arbitrage year (2.00% - 5.00% = -3.00%). However if the Participating Loan Rate was 5.00%, and the index credit was 9.00%, the client would actually gain 4.00% in that positive arbitrage year (9.00% - 5.00% = 4.00%).
This is why my backtesting software’s capabilities are so valuable, because they can mathematically articulate both types of scenarios in each given year so the client can actually see how the math works during times of volatility.
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