How IUL Floors & Caps Work

The 0.00% floor sounds too good to be true, doesn’t it?

Years ago when I first heard about this IUL feature, I thought the same thing.  Most people do not truly understand how this feature actually works, and this seemingly mysterious black box makes intelligent people skeptical (as they should be).  I am still shocked that the life insurance industry does not do a better job of explaining how the floor & cap proposition mechanically works in practice, because once you understand it, you will appreciate just how well thought out (and how sustainable) this design element truly is.

To understand how an IUL’s crediting method works, we must first discuss the origin of permanent life insurance policies in general.  We will start with one type of permanent life insurance policy: Whole Life.  

Whole Life is not synonymous with the category of ALL permanent life insurance policies.  Whole Life is one of several different types of permanent life insurance.  Compared to Term life insurance (which expires after the term period), Whole Life was originally designed to give a person life insurance coverage that would last for their whole/entire life, hence the name Whole Life.

The general concept was that the premiums (approximately four times greater than Term insurance premiums) would not only pay for the cost of insurance, but the excess premiums would be invested in the life insurance company itself (somewhat similar to buying stock in the insurance company – not exactly, but similar).  These excess premiums invested in the life insurance company would yield a dividend based on how well the life insurance company’s overall investment portfolio did in the previous year.  

A dividend would be declared, then it would be credited to the policy’s cash value the following year.  The cash value would then be used to pay for the ongoing Cost Of Insurance (long after the insured person stopped paying premiums) which enabled the policy to last until the end of the insured person’s life – insuring them for their whole life.  To give you an idea of how stable these Whole Life dividends have been over time, below are the historical dividend credits over the last forty years of four major Whole Life carriers. 

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