The Impact of AG 49-B on IUL Products

The landscape of the Indexed Universal Life Insurance (IUL) marketplace is experiencing rapid shifts with new products being released in response to AG 49-B.
Before I get into the current marketplace, I feel it is necessary to provide some context for this article. Let’s start with the history of Actuarial Guideline 49 (AG 49).

The History of AG 49

AG 49, which was implemented on Sept. 1, 2015, by the National Association of Insurance Commissioners (NAIC), imposed stricter restrictions on policy illustrations for IUL products. In short, AG 49 lowered maximum illustrated rates based on the lower of the geometric mean of the past 25 years of the index (based on current caps and floor) OR 145% of underlying portfolio supporting the product. Furthermore, the maximum spread on loan rates was capped at 1% of the crediting rate.

The Rise of Multipliers

Unfortunately, these new regulations had unintended consequences. Companies “found a way to build a better mouse trap”, so to speak, and introduced “multipliers” to their IUL illustrations. There are 2 main reasons multipliers became an almost requirement to be competitive in the illustration wars:

They allow for the loan spread to be larger than 1%
They allow for a higher rate of return while still complying with the max illustrated rates (145% of underlying portfolio return and geometric mean of the index).

How does a multiplier allow for a greater than 1% spread on a variable or indexed loan? This is best explained by an example: let’s say I have a product that I can illustrate at 6.5%. If you run the illustration at 6.5% the loan rate is required to be a minimum of 5.5%. This product also has a 170% multiplier on the index, and it has an expense charge of 3%. Insurance companies used a formula to bump up that percentage, for example: (1 * (1-0.03))(1+(0.0651.7))-1= 7.72% . You are getting a 7.72% rate of return in the policy which means your spread is up to 2.22%!

Although this is how the product may actually perform, it leads to a much more aggressive than expected illustration and completely negates the intent of AG 49 to begin with! If you ask me, this was an ingenious way to get around these restrictions. Unfortunately, it has created even more confusion and makes it even harder to compare products “apples to apples”. Really the consumer is the one who may not understand the underlying risks. Which leads us into the second iteration of AG 49…

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AG 49-A

Since the original AG 49 was introduced, most companies have been rolling out their, what I would call, “AG 49 IULs”. Usually, they have some type of multiplier to boost the interest credits and maximize income/loans. This prompted the NAIC to revisit AG 49 and crack down on overly aggressive illustrations.

The original intent was to try to prevent confusion… It really missed the mark. To “prevent confusion and promote easier to compare illustrations” they decided that products with multipliers, cap buy-ups, and other enhancements that are linked to an index should not illustrate better than a product that does not have those features. As such, new guidelines were introduced:

Limited policy loan spread to 50 basis points (0.5%)
Eliminate the ability to illustrate the effect of multipliers

In response, insurance companies found an even better way to build a mouse trap…

Engineered Indices

These indices are created by banks and asset managers specifically for use in indexed insurance products. They tend to have three primary attributes.

They have exceedingly high lookback performance, typically much higher on a risk-adjusted basis than established indices that have been in market for decades.
They are very cheap to hedge. This allows life insurers to offer, for example, more than 100% participation in the index performance without a Cap even with a modest portfolio rate.
To achieve the first two, the indices are usually extremely complex and opaque.

Engineered indices provide companies the ability to perform a “sleight of hand” in order to increase illustrated performance. The idea is relatively simple: The maximum illustrated rate for any IUL is determined by the S&P 500 illustrated rate. Let’s say it’s 6.25%. To provide exposure to the S&P 500, the company buys options. Let’s say it costs 5% in order to buy enough exposure to the S&P 500 to illustrate at 6.25% based on the lookback methodology.

Engineered indices provide a more efficient solution. To illustrate the same 6.25% rate based on the S&P 500 index, a company might only have to show a 3.5% portfolio rate rather than 5% for the S&P 500. This allows the company to divert the 1.5% in savings into a fixed interest bonus which can be added to the illustrated performance of the product. Now a company can illustrate a total rate of 7.75% for the engineered index, a substantially higher rate than the S&P 500, while showing the assumed rate of return as 6.25%.

Which leads us to the present day.

AG 49-B

In response, regulators drafted AG 49-B to specifically address this issue. At the heart of these revisions is a very simple concept. AG 49-B will essentially normalize illustrated rates for all accounts with the same option budget. Accounts with option budgets higher than the Benchmark S&P 500 will have no illustrated benefit and accounts with options budgets lower than the Benchmark will illustrate lower.

The relationship between the illustrated rate on the Benchmark S&P 500 account and the portfolio rate establishes a ratio. In the example above, the ratio between the 6.25% illustrated rate and the 5% portfolio rate is exactly 25%. So, if an index has a 1% interest bonus the illustrated rate would be: (The Portfolio Rate minus 1%) * (the ratio). In this example the calculation for the max illustrated rate of this index would be 4% * 1.25 = 5%.

Therefore, all indexed accounts with identical portfolio rates will illustrate identical maximum illustrated rates. Accounts with higher portfolio rates will illustrate the same as the Benchmark S&P 500. Accounts with lower portfolio rates than the Benchmark S&P 500 will illustrate at lower rates, including those with fixed interest bonuses. Bonuses on specific strategies, such as low volatility strategies, can still exist, however, they will illustrate much lower rates than benchmark caps.

So where does AG 49-B leave us? Certainly, in a better place than under AG 49 and AG 49-A. This is probably the closest that IUL illustrations have come to the original intent of AG 49, which was to provide clarity and make it easier to compare life insurance products.