The Siller & Cohen Report

S i l l e r & C o h e nFamily Wealth Advisors

2nd Quarter 2014

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Indexed Universal Life Insurance

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Indexed Universal Life Insurance

As the economy and market conditions change over time, the life insurance industry develops new products that meet the changing needs of consumers. One of the more popular life insurance products now is Indexed Universal Life (IUL) insurance, which represented 35% of all individual universal life insurance

policies sold in 2013 1. In this article, we’ll take a look at what IUL is, how it differs from other types of universal life insurance policies, how it works, and what its advantages and disadvantages are.

In order to understand how an IUL policy differs from a traditional Universal Life (UL) policy or a Variable Universal Life (VUL) policy, a little background in the economics of life insurance policies will help.

In all permanent (cash value) life insurance policies, the true cost of providing the insurance protection (the death benefit) for each year, called the “mortality expense”, is deducted from the policy cash value each year. The annual mortality expense amount goes up each year, because as the insured person grows older, the statistical likelihood that he or she will die increases. In the early years of a policy, when the annual mortality expense is lower (because the insured person is younger), the excess annual premium, that is, the amount by which the annual insurance premium exceeds that year’s mortality expense 2, is deposited to the cash value account, and over time the cash value of the policy has the opportunity to grow.

The cash value can be used in two ways. First, in most annual premium policies, and because the mortality expense increases each year, there will come a time (the “crossover year”) when the annual mortality expense is more than the annual premium. When this happens, the policy owner can often continue to pay the same level annual premium, and each year’s shortfall in mortality expense will be taken out of the policy cash value. In this way, the growth of the cash value in the early years of the policy supports the policy in the later years. Second, if the policy cash value grows sufficiently, the owner of the policy can withdraw some of the cash value on a potentially income tax-free basis, to be used as supplemental retirement income, or for any other purpose. (Note that such withdrawals may reduce the death benefit.)

One key difference between a UL, a VUL and an IUL policy is what the growth in the policy cash value is based on.

1. In a UL policy, the cash value grows based on an interest rate set each year by the insurance company, based on the earnings in the insurance company’s general account, which usually approximate general market interest rates for high quality bonds.

1. Insurancenewsnet.com, April 7, 2014. 2. Plus company operating costs and other expenses also deducted from cash value.

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2. In a VUL policy, cash value can be invested in a wide variety of separate accounts, with any mix of stocks and bonds that the policy owner chooses. By choosing a mostly stock mix, the cash value of a VUL policy can enjoy strong growth in those years in which the stock market does well. But of course, just as with any other stock invest-ment, if the stock market goes down in any year, the policy cash value will lose money, which may require the policy owner to (1) start paying higher premiums, (2) accept a lower death benefit, or (3) accept the risk that the policy expires worthless before the insured person dies. [Note that this discussion does not address the ability to add an additional feature to some VUL policies that will guarantee the death benefit regardless of the underlying investment performance].

3. An IUL policy falls somewhere in between, by allowing the cash value to benefit from gains in the stock market, while also protecting the cash value in years when the stock market is down. While specific policy details may vary from company to company, here is how an IUL policy offered by one highly rated insurance company works:

The growth of the cash value each year is linked to the S&P 500 Index (the “Index”). The movement of the Index does not include dividends. In years when the Index is down, the company guarantees that the policy cash value will increase by 1%, before policy expenses. In good years, when the Index is up, the policy cash value also goes up. How much it goes up depends on the index crediting formula selected by the policy owner when the policy is first purchased. For example, three crediting formulas offered by this one company are:

i. Policy cash value will be increased by the same percentage as the Index increase, multiplied by a “participation percentage” of 140%, but subject to a maximum increase of 10% (a “cap”). Examples: (1) If the Index is up by 4% for the year, the policy cash value will be increased by 5.6% (4% X 140% = 5.6%). (2) If the index is up by 8%, the policy cash value will be increased by 10% (8% x 140% = 11.2%, limited by the 10% cap).

ii. Policy cash value will be increased by same percentage increase as the Index, with a cap of 12%. Examples: (1) If the Index is up by 9%, the policy cash value is increased by 9%. (2) If the Index is up by 21%, the policy cash value will be increased, but only by the 12% cap.

iii. Policy cash value will be increased by a lower “participation percentage” of 65% of the Index, but is not subject to any cap. Example: If the Index is up by 35%, the policy cash value will be increased by 22.75% (35% x 65% = 22.75%)

It’s important to point out that this article is focused on how policy cash values might grow depending upon the insurance product you choose, however, other important differences also exist between different types of policies, including internal cost structures, and the possibility of additional guarantees available on some products but not others.

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In conclusion, IUL policies are appealing because the policy owner gains the opportunity for the cash value to ben-efit from potential stock market gains, and as a result may grow much quicker than in a UL policy, but at the same time, is protected from significant losses that could be experienced in a VUL policy, where the cash value would be fully exposed to down years in the stock market. This reduced volatility may provide better investment performance over time, as well as comfort in down market years. That said, it’s important to note that like every cash value life insurance product, IUL policies are subject to internal expenses, as well as surrender charges. Because the policy cash value is linked to the Index, but is not actually invested in the Index, the cash value doesn’t benefit from any dividends on the stocks that make up the Index. In addition, the insurance company has the power to change the cap in any given year, and could potentially set a lower cap, which would limit the increase in the cash value in a good stock market year.

Whether an IUL policy would be suitable for you depends on your insurance and investment objectives, as well as your unique personal situation, but it is a valuable tool to be considered, whether purchasing a life insurance policy for the death benefit, or for supplemental retirement income.

We hope this information has been of value to you. Please don’t hesitate to call us with any questions.

Economic Highlights1. DON’T STOP NOW - The bull market for the S&P 500 began its 64th month as of 6/09/14. The current bull is the 11th bull market for stocks since 1950. 3 of the previous 10 bulls lasted at least 6 years, i.e., 72 months. The longest bull market for the S&P 500 since 1950 lasted 9 ½ years, running from a bear market low on 10/11/90 until it peaked on 3/24/00 (source: BTN Research).

2. THE BEST WE CAN HOPE FOR? - Over the last 40 years (1974-2013), government outlays have averaged 20.5% of the size of the US economy while tax revenues have averaged 17.4% of the size of the US economy, an average shortfall (i.e., deficit) of 3.1% of the size of the economy (source: Congressional Budget Office).

All guarantees and benefits of the insurance policy are backed by the claims-paying ability of the issuing insur-ance company. They are not backed by the broker/dealer and/or insurance agency selling the policy, or any affiliates of those entities other than the issuing company affiliates, and none makes any representations or guarantees regarding the claims Variable universal life insurance is sold by prospectus. Carefully consider the investment objectives, risks, and charges and expenses of the policy and its underlying investment options. This and other important informa-tion can be found in the prospectus for the variable universal life policy and the prospectus for the underlying investment options. Prospectuses are available upon request and should be read carefully before investing or sending money.

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S i l l e r & C o h e nFamily Wealth Advisors

BROUGHT TO YOU BY ABOUT SILLER & COHEN

Randy P. Siller, CPA1, Masters in Tax, CIMA®,CRPC®Principalrsiller@sillerandcohen.com

Jeffrey S. Cohen, CFP®Principaljscohen@sillerandcohen.com

Siller & Cohen is a boutique family wealth advisory firm providing financial solutions for the past twenty-five years to institutions and high net worth individuals. We combine the detail and careful attention of a smaller firm with the deep resources of a national organization. Our team includes CPAs1, Certified Investment Management Analysts, and attorneys.1

While we offer our clients the full range of planning services, our core areas of expertise include wealth transfer, investments, and business succession planning.

A member of Siller & Cohen has been named by Barron’s Magazine as a Top 100 Investment Advisor for 11 Consecutive Years!2

1 Licensed, not practicing2 The list was compiled by RJ Shook, Financial Industry Consultants. This is an objective ranking based on assets under management.

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Associates of Siller & Cohen are registered representatives of Lincoln Financial Advisors Corp. Securities and advisory services offered through Lincoln Financial Advisors Corp.,a broker/dealer (Member SIPC) and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. This material is for information purposes only. We do not offer legal or tax advice. Seek the advice of a tax advisor prior to making a tax-related insurance/investment transaction. Any discussion pertaining to taxes in this communication (including attachments) may be part of a promotion or marketing effort. As provided for in government regulations, advice (if any) related to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. Individuals should seek advice based on their own particular circumstances from an independent tax advisor. CRN-965277-071114

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