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Consumers Flock to Indexed Universal Life Insurance, But Advisors Urge Caution

June 11, 2015
Insurance, Life Insurance
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There are so many types of life insurance to choose from, it can be tough to keep them all straight. Some types even have subvarieties.

Indexed universal life insurance has been riding a wave of popularity for several years and was the fastest-growing segment of the individual life insurance market in 2014, making up 52% of universal life premiums paid and 20% of all individual life insurance premiums paid, according to life insurance research organization LIMRA.

Indexed life insurance is complicated, and for most people, term life insurance is more appropriate. But if you are considering indexed life, here are a few things to keep in mind.

A twist on traditional universal life

Like other permanent life insurance products, indexed universal life insurance is made up of a death benefit and a cash value portion. The difference between indexed life and other policies is in how growth is credited to the cash value. Life insurance companies typically use their own proprietary calculations to decide cash value additions, but with indexed policies, consumers can choose to have growth added to their cash value based on the performance of an index, like the NASDAQ composite or S&P 500. If the index goes up, your cash value will, too – up to a point.

Returns are more predictable

“In my opinion, indexed universal life insurance is the best life insurance product on the market,” says Guy Baker of Wealth Teams Solutions in Irvine, California. It’s flexible, and “gives the highest probability of a substantial long-term return on investment,” he adds.

For many people, the relative transparency of indexed life insurance is another huge selling point. Your returns are by no means guaranteed, but it is easier to understand how they’re determined.

Indexed life insurance also offers “a floor for the cash value,” according to Chris Chen of Insight Financial Strategists in Waltham, Massachusetts. This is a benefit for those who are market-shy: Even if the index you track is down 10% for a given year, your cash value shouldn’t decrease and may even increase slightly, depending on your policy.

Performance may fall short of projections

Yet indexed life insurance is not without controversy, and many professionals suggest staying away.

The name “indexed life insurance” may conjure up images of stock-like returns, but that’s not what you’ll get, warn some advisors. “Insurance company illustrations of indexed universal life insurance seem to be very optimistic,” Chen says.

Because your cash value isn’t really invested in the stock market, the gains you receive will almost never equal market performance. And if the market has a particularly good year, growth caps will usually prevent you from receiving the full extent of the earnings. High costs can also eat into your returns, Chen says.

And if you do decide to go ahead with an indexed policy, “it’s important to annually check the illustration [of returns] that was used at issue with the actual results,” Baker says.

A New York state regulator launched an investigation into the product last year to determine whether carriers were offering overly optimistic projections of their performance, according to The Wall Street Journal.

Term life best for most consumers

Indexed universal life insurance may not provide the returns you expect, but it does have some advantages, and it is good for some consumers – especially those who have a need for permanent life insurance.

“In my opinion, because indexed universal life insurance is fundamentally an insurance policy, it works best as a somewhat lesser-cost alternative for whole life insurance,” Chen says. If you are interested in indexed life or another form of permanent life insurance, you should check with a qualified financial adviser.

For most people, Chen still recommends the basics: “For people who need insurance coverage, term life is a much more cost-effective tool,” he says.

Alice Holbrook is a staff writer at NerdWallet, a personal finance website. Email: [email protected]. Twitter: @alicenerdwallet.

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