Understanding the Interest Credit Strategy in an EIUL

by | BiggerPockets.com

Equity indexed universal life insurance policies were developed in response to issues in the variable universal life policies. Despite this, to this day, some critics lump the two together. For retirement purposes the EIUL uses a far superior strategy. Let’s take a look.

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EIUL Interest Credit Strategy

Variable products simply use sub-accounts that are usually mutual funds inside a life insurance wrapper for tax favored treatment. As a result, you have the usual issues with mutual funds [ex. sequence of return risk], plus have to deal with front loaded fees of life insurance that can cause a policy to need more cash inputs early in its life. Equity Indexed products were designed to avoid these issues for a more stable product. It is important to note that money inside EIULs are not invested in the market. An EIUL is considered a fixed rate product, hence gets an interest credit tied to a stock index or group of indexes with a ceiling [cap rate]and a floor [usually 0%]. Because you are depending upon the overall investment portfolio of the insurance company it is important to purchase an EIUL from a stable and top rated life insurer.

Because you are not a victim of the full variance of the market, its losses as well as its big upward movements, you end up with a higher average rate of return in almost all 20-30 year historic time periods as well as mitigate sequence of return risk. Let’s look at a 20 year historic comparison of strategies.

Compare investing in the index versus EIUL strategy with a 15% cap

S&P 500 Index EIUL Interest Credit

EIUL Vs Index

Here are some notes: 8 out of the 20 years there were identical returns from the two strategies. Six out of the remaining 12 years [or half]the straight index beat the EIUL strategy. Now let’s see what the results are.

If you invested $1000 in both strategies, at the end of 20 years [without consideration of expenses]you would have:

Index $3,272
EIUL $4,809 [47% more]

Compound Annual Growth Rate
Index 6.11%
EIUL 8.17%

More Notes: Negative numbers hurt much more than big positive numbers helped. After 1999 the stock index was worth $3,327 while the EIUL strategy was $2,153. Money invested in the stock index hadn’t reached that 1999 peak by the end of 2012 [13 years later].

Related: Real Clients and Real Results Using EIULs

It’s the Strategy, Stupid

When I get calls from people who try to compare an index’s returns to the interest credit inside an EIUL, the first thing I need to get them to understand is that they are comparing apples to oranges. The strategy employed inside an EIUL gives you more consistent growth, eliminates those really scary year returns [2002,2008], and in almost all historic time periods provides higher compound growth rates.

On top of the math, there is the psychological aspect. Study after study provides evidence of what happens when people see a really bad market. They panic and sell low. It also provides evidence of what happens in a good market, they get all giddy and buy high. This is what drives the overall underperformance of individuals compared to the actual mutual funds they are purchasing.

So from both a market perspective and a behavioral perspective the EIUL strategy works better for most people.

Photo: StockMonkeys.com

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  1. I know you had mentioned in the past that fees are considerable for the first 10 years or so (that is, don’t take money out during that period) but you opted to leave fees out of your equation above.

    In my Roth IRA, for example, I pay $7 to do a trade and I tend to take a long time to pick a company that I’m willing to ride for at least 5-10 years before reevaluating. My question is, when you add in fees, how does the EIUL plan work in comparison?

    • Joshua and David,
      EIUL has always interested me as a place to safely stash some cash. I am very interested in the fee’s also. I know that each policy is very different and based on life parameters and generally requires consultation. An example of a health, non smoking, married, two kids, home owner 35 year old male starting with 100K as a one time premium on Jan 1 with a market index increase of 0 or negative will have an account worth ??? on December 31 of the same year. This would help many people understand the model used hopefully show how reasonable the fees of this product are.

      Should probably also show how much insurance is provided, although that, in this case is a secondary concern and not the intention of the investment.


    • I knew this would come up and I should have mentioned that next week I will post on the fee’s and tax issues [they should be considered together with the overall interest credit].
      In short, the fee’s are mostly front loaded. As such, again you can’t make an direct comparison to mutual funds. In general, the total costs inclusive of all fees and cost of insurance], as expressed as a percentage, ranges from .5% to 1.8%, depending on age, gender, premium payment timing, and age of death [assuming you die after age 68]. Earlier death will produce positive leverage to your money rendering the return greater than what you received as an interest credit. That is why most people when they get interested in the product, get a full illustration from me, which includes fee’s, expenses on a yearly basis, and internal rate of return. It also demonstrates why this is not an appropriate vehicle for the short-term. It’s called permanent life insurance because it is designed to be kept until death.

  2. David,

    Could you please explain the inner structure of EIUL? Is is essentially a bull options spread on a given index financed with interest from some uncorrelated bonds?
    How does it manage not to lose anything if a benchmark index turns negative?


    • Nick, the internal structure is pretty simple, the life insurance company pays an interest based on the movement of an index or group of indexes with a 0% floor and a movable cap rate that averages around 15%. You are not invested in the market as a policy holder. The insurance company invests to do two things to support the product. There is a 3% guarantee on the interest credit, that they must cover through fixed rate bonds. The remaining premium they use to purchase european style options on the index. The cap rate moves in response to two interrelated factors. The overall interest rate environment which can cause them to use more of the premium to get the 3% guarantee in low interest rate environments and the cost of the options. We are obviously in a low cap environment at this time.

      • David:

        When you say, “We are obviously in a low cap environment at this time.” it makes me thinkg of another question. You had mentioned previously that there are different cap rates (ceilings of allow returns of say 15% but no less than 0%). My question is: Should I wait to get involved in an EIUL plan until that rate improves or does it generally hover around a certain rate and so really doesn’t matter too much (i.e. like timing the market), etc.?

        • The difference in cap, even if you could predict when it will move, would result in so small a difference that it is not worth it. This is a long term strategy, so the best time to do it is as soon as you can as the length of time you have is much more important.

  3. Jeff Brown

    “So from both a market perspective and a behavioral perspective the EIUL strategy works better for most people.” Could be the EIUL related understatement of the last several years.

    “It’s the strategy, stupid.” It’s investors not understanding the core value of the strategies available to them that dooms them to either mediocre portfolio performance, or outright failure.

    You say most things far better than I do, David.

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