Changing financial tides could hit IUL cap rates

When will interest rates, index caps and policy crediting reverse course?

By Kyle G. Mills

Indexed universal life (IUL) cap rates have reached low tide, which makes long-term projections much less attractive for current and future policyholders.

It is not hyperbole to say “every IUL policy sold in the last 10 years illustrates lower today than it did when it was sold,” assuming maximum illustrative rates. Some will argue this, but that does not provide answers about the future of permanent products, including whole life, IUL and universal life (UL).

Interest rates have been trending down for decades. When will interest rates, index caps and policy crediting reverse course?

Here are two of the most common distractions regarding crediting.

1 – Short-term interest rates

Short-term interest rates refer to the federal funds rate set by the Federal Open Market Committee. Rising interest rates do not translate to higher cap rates in the short term because higher interest (and volatility) increases the cost of options that insurers buy to create the cap and floor that define a typical S&P 500 index account. The easiest way to validate the disconnect between interest rates and index caps is to look at data from the last rising interest rate cycle from 2016 to 2019.

IUL caps versus increasing interest rates

The chart above shows that eight interest rate increases had almost no impact on cap rates. At the end of the cycle in 2019, interest rates were still increasing and caps were still going down. To borrow an analogy from a colleague, “short-term interest rates are just waves splashing against the Titanic.”

A corporate bond index is a better barometer for potential changes in cap rates. If increases are sustained month over month, the yields will show up as profits in general accounts (GAs). At the 2018 peak, you can see an inflection point where AAA yields slightly alter the downward trajectory of caps, but not enough to reverse course.

General account assets as percentage of total

Why does the industry devote so many resources to the index game? Perhaps the steady introduction of new indexes

2 – Index options

This is one of the great headfakes in product marketing. Life Insurance 101 taught us that all UL products, including IUL, are general account products. Therefore, by definition, IUL premium dollars are invested in the carrier’s GA portfolio, not an index fund.

Index accounts are shadow accounts. They are a sandbox of equities where marketers can model hypothetical results using various caps, floors, spreads, indexes, derivatives, loan strategies, volatility controls, etc. that are not directly associated with the investment of client money.

has become a marketing platform of its own. It is a convenient distraction where increasingly complex market schemes are molded for point of sale and then unceremoniously eroded by the reality of general account investments.

When the index honeymoon is over, the long-term performance of insurance products is tethered to the insurer’s GA, specifically net investment yield, by a leash that has been getting shorter and shorter.

The chart to the right makes it clear that net investment yield is the ugly truth behind product performance, which also makes a good starting point for better analysis.

ALIRT life industry composite – Net investment yield

In general, net investment yield is the source of funds that carriers use to determine product budgets (plus whatever the carrier is willing to commit to new business acquisition). It is no surprise that caps and crediting have followed this same trajectory.

So what drives net investment yield? Investment grade bonds make up 65% of yield potential. The good news is bond yields are on the rise.

A 50/50 mix of Aaa and Baa corporate bond yields have risen from 3.12% to 5.48% in 2022, according to FRED, the Federal Reserve Bank of St. Louis. The steep climb in yields may offset the increased cost of options.

So far, the industry has not seen a wave of fresh cap decreases that many analysts projected. Instead, fixed crediting accounts have begun to increase rates, which could lead to increases in IUL cap rates in the next six months or more.

Insurers with a diversified mix of assets have fared better than those who rely too heavily on bonds. The table below underscores how small alternative investments can have a disproportionate impact on GA yield:

5-Year averages (2017-2021)

Alternative investments are private equity funds, hedge funds, joint ventures and other high-risk/high-return investments. Insurers’ investments in alternative assets

10% Significant changes increased 23% from 2017 to 2021 as a supplement to low bond yields, in demography and according to ALIRT Insurance Research. globalization may The beginning of this article questioned the future direction of support a full-scale long-term interest rates and policy crediting. We can only speculate, reversal that is already but some economists think fun damental macroeconomic con underway. ditions are changing. There are signs that the past three decades of deflation and decreasing interest rates bottomed out in 2021. Significant changes in demography and globalization may support a fullscale reversal that is already underway. Specifically, an aging and shrinking work force and political opposition to global trade may drive inflation and interest rates for the foreseeable future. If the forces that pushed portfolio yields down for so long are reversing, it is logical to think yields themselves will go in the other direction as well. I am optimistic that the new economic environment will bring higher caps and crediting to index-based insurance products by the first half of 2023.

Kyle G. Mills is a senior life analyst at Schechter. He may be contacted at kyle.mills@innfeedback.com.

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MYGAs lead the way in 3Q annuity sales

$30.000 $28,000 $26.000 $24,000 $22.000 $20,000 $18.000 $16.000 $14.000

Experts are expecting monster sales numbers $12.000 $10.000 for the fourth quarter and 2022 overall for multi- $8.000 year guaranteed and indexed annuities, while $6.000 $4.000 variable annuities and their hybrid offspring, $2,000 structured annuities, are in for a bumpy ride.

MYGAs blasted over the past few quarters, with $27.4 billion in sales in the third quarter, 4.7% over the previous, stellar quarter and 138% over the third quarter of last year.

Sheryl Moore, CEO of Wink Inc. and Moore Market Intelligence, credited MYGAs’ success to outcompeting CDs. MYGAs lock in rates for multiple years, just like CDs but at a much higher rate. According to Wink data, the average MYGA rate is

4.34%, while the average CD for a year is 1.16% and the five-year is 1.05%.

Variable annuities, however, have slumped with the stock market. VA sales, not

including structured annuities, amounted to $13.3 billion in the quarter, down more than 15.9% compared to the previous quarter, and 37.8% over the same

period last year. VAs have had a mighty fall since 15 years ago, when the products used to outperform all fixed annuities.

DATA: PANDEMIC LIKELY SPED UP ANNUITY PAYOUTS

Did more people access their annuity funds because of the pandemic? Some experts think so.

Annuity payments increased 7.4% in 2021, the American Council of Life Insurers found in its 2022 ACLI Life Insurers Fact Book, released recently.

Life insurance companies paid $100 billion to beneficiaries of life insurance policies and $97.7 billion to annuity holders in 2021, both record highs for a

single year, ACLI said. Annuity payouts were well above the annual average for the past decade, the trade association found.

It is possible the pandemic influenced changes to retirement plans for many, said Andrew Melnyk, ACLI vice president, research and chief economist. “One reason may be the increase in the number of people who retired early during the pandemic,” he said. “As a result, they may have taken their annuity payments before they had planned.”

MANY DUPONT PENSIONS CONVERTED TO ANNUITY

Many DuPont retirees are seeing a conversion of their retirement pension plan to an annuity, which will be administered by insurance giant Prudential.

Parent compa ny Corteva issued the following notice:

“As disclosed in Corteva’s 3Q22 10Q, the company transferred obligations and assets from the U.S. pension plan to purchase a group annuity in August 2022 for a portion of the pensioner population.”

This change in the pension plan has no impact on the pension benefit amount. Payments begin at the year-end.

The change had been widely expected after Corteva ended up with DuPont’s retirement obligations upon the merger and spinoff of Dow and DuPont. The main goal was the formation of Corteva, which combined the agribusiness operations of Dow and DuPont.

QUOTABLE

The average fixedrate deferred [annuity] crediting rates continued to be more than triple the rates offered in bank CDs in the third quarter.

— Todd Giesing, assistant vice president, LIMRA Annuity Research

ANALYST: DOL BETTER RELEASE FIDUCIARY RULE SOONER RATHER THAN LATER

The Department of Labor better not wait too long to publish its redefinition of “fiduciary,” one industry analyst said recently.

The DOL’s spring 2021 Regulatory Agenda confirmed that it will rewrite the definition of fiduciary, which is likely to dramatically impact annuity sales processes.

Ever since, the Employee Benefits Security Administration has likely been working on the rule update.

It’s hard to say for sure, said Brad Campbell, partner at Faegre Drinker law firm, since the DOL does not provide much information on its work.

As of early December, there were no plans to release the rule, a DOL spokesperson said.

As the halfway point of President Joe Biden’s term nears, the pressure increases to speed along the rulemaking, Campbell noted. Otherwise, we could see a Republican administration come in after the 2024 election and reverse all rulemaking to that point.

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