Charlie Gipple, CFP, CLU, ChFC

On March 9 we passed the ten-year anniversary of the bull market that started in 2009; almost tripling the duration of the average bull market. Since March 9, 2009, the S&P 500 has quadrupled. Now, by just looking at the duration of the bull market and comparing it to past bull market lifespans, that would be a rather simplistic approach to arriving at a prognostication of what the future holds in the market. Although my intent is not to “prognosticate” anything in this article, I have my opinions and will say that the more “analytical” approaches to coming to a prognostication would indicate that we could be in for a rough ride. I research the market a lot and I believe that more can be found in the behavior of the bond market than the stock market. Without going into a long description, I will say that inverted yield curve is not good! An inverted yield curve has preceded every recession in the last 60 years.

As we face the possibility of being confronted with significant angst from our customers, I thought it would make sense to repeat a message from one of my Broker World articles from a couple of years ago as I believe it warrants repeating.

About ten years ago I had a 6:00 am Southwest flight out of Omaha to Phoenix. I was dead tired because I had to wake up at 3:30 am to get on the flight. Nevertheless, I dragged myself to the airport. Waiting at the gate to get on the airplane seemed to take forever. All I wanted to do was get on the plane and take a nap. As I boarded the plane I was happy because there were probably about 50 people on the flight which would mean that I would likely have plenty of room to get comfortable and take my nap. Indeed, after I sat down I noticed that in my row it was just me and somebody across the aisle in the other seat that looked like he was probably a frequent traveler, as am I. Without going into detail, this guy looked the part. Anyway, as I sat there in my seat I started to doze off into a half-conscious state. I could feel the plane pull back from the gate and go through the long process of idling out to the runway. The feeling of the plane lumbering along through the obstacles to get to the runway is kind of a soothing feeling, a lot like rocking a baby to sleep. In my half-awake state I could then feel the plane’s full thrust kick in as I was pushed back in my seat. It was obvious we were now making our way down the runway. As we made it down the runway we were nearing the final stage where you just begin to feel the front wheel lift as we go airborne. Then, suddenly, BOOM! This is the point when my whole world got rocked. It felt like we hit a brick wall as I was jolted wide awake. We were then skidding down the runway as I pulled myself to the window in panic to see where the end of the runway was because we had to be close. I also glanced over at Mr. Frequent Traveler across the aisle, whose eyes were the size of dinner plates. He was looking back at me for confirmation we were not going to die, which I could not provide him. He was panicking, the other passengers were panicking and, worse of all, the flight attendants were panicking! By the way, when the flight attendants panic, you should panic too!

What felt like a lifetime finally came to an end. We finally slowed down and got it under control. As the dust settled and we began that slow idle back to the gate I could hear people sobbing toward the back of the plane. That is when the captain came on the intercom to tell us what had just happened. What did he say? In a very calm and stoic voice he comes on and says “Hello folks, sorry about that somewhat uncomfortable take-off attempt. As we began to get airborne we had a diagnostic code tripped in the system that indicated the right-side engine was failing so we had to abort our take off. We will have to take you back to our gate and see what we need to do to get you on your way home. We do apologize for the inconvenience and greatly appreciate your patience as we get you home safe and sound.”

With those calm words from the pilot, suddenly everything seemed OK! You would have thought that the pilot had been there and done that a million times! Isn’t it amazing how a few calming words can put you at ease? I had flown hundreds of flights a year up to that point and I knew that this incident was not normal for me nor for anybody else, including the pilot! I knew that flight was a near death experience. I knew this, my friend across the aisle knew this, and the flight attendants knew this. Even more interesting is, even though I also knew that it was the pilot’s job to project a sense of calm even if he were to think we were all going to die, it still worked! A lot like when you tell yourself a salesman is going to try to sell you something and you aren’t going to buy it. But once you hear the pitch you buy it hook, line, and sinker.

The calm reassuring voice of the pilot put me and everybody else at ease even though I knew it was his job to create a false sense of security. The pilot became an instant hero. As a matter of fact, as we were deplaning I noticed several people hugging the pilot as they walked past.

When we got into the gate I called my friend who worked for another airline who pulled the incident up in his system. He said that incident I had just gone through was indeed a very big deal. He said that the airplane had been so far into the takeoff process that it passed what is called “V1” which is basically the speed of no return. He had stated that for the pilot to make the call to abort the takeoff at that point was a tough call because it was a choice between either getting airborne and having the plane fail in the air or aborting and running out of runway and crashing on the ground. The pilot chose option number two and fortunately it turned out fine.

My point is, you are your clients’ airplane captain. When they call you up because they are hitting turbulence in their lives, whether because they are losing money in the market, have a death claim, a long term care claim, etc., your value in these times lies in the way that you handle the situation. This is your opportunity to become a hero by doing the opposite of panicking and instead being a steady hand to those that are panicking. This is what top financial professionals do. They project a sense of “I have been there and done that and we will remedy this situation.” Imagine instead if that pilot came on the intercom and screamed out “Take cover! We are all going to die!” Panic is contagious and so is calmness. And people remember the “heroes” that gave them calmness in times of distress.

Are you that calming voice even at times when you are also scared for the client?

When I was getting started in the business there were times where I would get “panicky” because of a big meeting I had to conduct, a bad message I had to give to somebody, or a large audience I had to present to. I had a mentor back then who would always say, “You have done this a million times, and have you failed yet? No, you haven’t! So why panic now?” He would then go on to say “So what is the worst that can happen if you were to fail? It’s not like they can kill you.” For some strange reason those words have always stuck with me, “It’s not like they can kill me.”

We take our business very serious but keeping a perspective of what is important in life will also help you to not panic when things get stressful. We tend to let the negative trash in our heads believe that it’s a life or death situation if we fail at a task. It is not. This is why I have the utmost respect for our courageous men and women in the military. Their bad days on the job are way beyond the average person’s.

Not panicking is not only healthy for you, it is also healthy for your clients and your relationship with those clients. This is because having a positive mindset is a self-fulfilling prophecy. Meaning if you are always positive and never panic, clients feel that and will, in turn, be positive and will not panic. You are looked at as the “pilot” and therefore the creation of a positive environment is in your hands. Prospects/clients look to your mindset to form their own. And, the mindset that you have over the coming years could be extremely important if the market does what it is overdue to do.

Also remember, in almost any study out there that asks consumers why they left their advisor, the top response is almost always about communication or lack thereof. When the going gets tough, the tough communicate with their clients.

Is this you? You have had a successful career and you feel like you have worked your tail off. As a result, you have always gotten over the obstacles that you have been presented with—at least so far. You know you are not an idiot, you’re a quick learner and you have succeeded almost every-time—at least so far. You are a student of the business and not only know the business but also how to effectively communicate the need along with that need’s respective solution. Whether your customers have been financial professionals or retail clients, those customers have always given you great reviews and as a result you produced—at least so far. You feel like it doesn’t matter what type of product or service you are given, you will always be able to use hard work and effort to make sure that you succeed—at least so far. Do you love your work, your quality of work and take pride in doing a good job as well as getting well compensated for it? Is this you?

Is this also you? As much fun as you have had over your career and as much money as you may have made, you have begun to feel somewhat of a sense of emptiness. Is this emptiness brought about by the feeling that you are not able to influence your business as much as you would like because, in short, you work for somebody else? Furthermore, do you feel that, because you work for somebody else, the ideas that you would like to run with—that you know from your vast experience will work—are not being implemented? Do you feel that there is an imbalance between how much you care about your job and how much your job cares about you? Is this you?

Now, is this also you? Have you occasionally thought to yourself, “Then why don’t I start my own IMO/GA/agency?” But every time you ask that question, does the devil in your ear say that you will fail? That devil in your ear says, “Yes, you have been successful, at least so far, at almost everything you have done—but this time is different. Starting a business is different and you will fail.” That devil in your ear has also said things like the below:

• “The amount of knowledge around technology that you need today is beyond you…after all, you are a salesperson!”
• “You don’t have enough contacts to get the business running quickly.”
• “The IMO/GA/agency business is consolidating and only the big ones will succeed.”
• “You need massive contracts in order to succeed, which are very hard to get at the outset.”
• “Staffing at the appropriate levels is astronomically expensive.”
• etc.
• etc.
• etc.

If you are somebody currently in the position that I just explained, or one of the many successful IMO/GA/agency owners that read this publication, you are probably nodding your head because you know what I am talking about. You are either there, or you have been there.

The purpose of this article is to explain my high-level observations since I started my own marketing organization months ago, after several years of listening to the devil in my ear and not doing so. If I can help somebody change their lives for the better by writing about my experience then it was worth it. Much of the fine details are beyond the scope of this article, so if you want further advice please contact me.

Just Do It
I remember as a kid seeing old western movies where the cowboy would pull up to saloon on his horse, get off the horse and take the leather “leash” and merely wrap it one time around the post in order to keep the horse from bailing while the cowboy went to drink. As a kid, I always wondered how that would keep the horse in place. Heck, if the horse pulled just a little bit instead of just standing there, he/she would realize that it can run free! That is the equivalent of the devil in our ear. That devil is the psychological “leash” that tells us to just stand there and not pull.

Your gut is almost always more accurate than the devil in your ear. If you feel in your gut that you are the person I described in the first few paragraphs, and if you are financially able to—then rip the leash from the post! The other concerns about your ability to handle the technology, etc. will take care of themselves once you jump in. That’s right. Jump in and figure out the minor details later! If you have a value proposition and a plan/strategy for getting that value proposition in front of the right people, don’t sweat the small stuff yet.

One year ago I never would have thought that I could create a website, an agent microsite, marketing material, or a company “network” in our office. I was wrong! This stuff is not that hard! Although I am getting to a point where I don’t have time to do all the minor stuff and am hiring for it or outsourcing it, I learned that I am much more capable than the devil in the ear told me I was. You would be the same if you are the person in the first few paragraphs.

Again, if you have a value proposition that is unique from your competitors, don’t worry about what the “bigger guys” are doing. We have all read about the success stories of companies like Microsoft, Apple and Walt Disney, and how they started their businesses when the odds were stacked against them. But they succeeded! If you have a unique and strong value proposition relative to your competitors you will succeed.

But first, a word of caution about money—because that is one of the top determinants, if not the top, of whether you are able to do this.

You Need Money To Make Money
Now the bad news. There is truth to the cliché of “needing money to make money.” While starting an agency is not like starting a construction business, where you might need several pieces of $500,000 machinery, you still need money. Your LLC can be started with merely a couple hundred dollars. However, there are many other expenses—most of them technology. Here is a list off the top of my head: Errors and Omissions (both personal and agency), state insurance licensing fees for each state, computers, printers, website provider, antivirus/firewall for your network, email service like Constant Contact, Gotowebinar/WebEx, prospect lists, agency management system, health insurance. And the last one: Ultimately, if your business starts taking off, you will need staff!

Two additional thoughts about “needing money to make money” are:

• I believe that, whether one is a principal of an IMO or just a personal producer, with today’s regulatory environment he/she should have an affiliation with a broker/dealer or an RIA firm—especially the RIA firm. The fiduciary genie is out of the bottle, if not from a regulatory standpoint then certainly from a client mentality standpoint. I have been asked a few times by some personal clients if I was a “fiduciary.” Now you are probably like me in that you always act in the clients’ best interest whether you are officially a “fiduciary” or not. However, licenses matter to the regulators! One of the first things I did when I started my business was to retake my Series 66 and Series 7 exams (I dropped them years ago). Not only did the exams cost money, but the fees associated with the BDs/RIAs range anywhere from $1,000 per year to upwards of $7,000 per year. I believe that in order to build a healthy business in financial services and to hedge against regulatory uncertainty you need a securities license. Starting your own business is an opportunity to start a business the healthy way.
• The main reason I believe you need a large cushion before you start your own IMO/GA is because of this: Relationships with agents are just like relationships with consumers. It takes time to develop. Before I elaborate, let me step back a second and discuss my opinion on the genesis of the negative reputation that “insurance agents” have. I think one of the reasons our profession has gotten the reputation it has is rooted in the way that many of us got started in the business. I was almost straight out of college when I worked as an agent for one of the big career insurance companies. I was on a “commission draw” that the company gave me for the first six months, which was good because I had virtually no money because I was young. On the very first day of my employment the clock started ticking for me to produce so I could offset that “draw” with commission. If this didn’t happen, I would be gone six months later. The urgency was huge. On day one I knew nothing about the business, but I did know the phone numbers of my friends, relatives, and even a few people I hadn’t spoken to in ten years that I was sure would be thrilled to get a call from me (sarcasm). Needless to say, over that first year I was more “aggressive” with potential customers than I am today. Why? Because I needed to be. I needed to put food on the table! I had no cash cushion.

The fact that I have been smart with my money over the years allows me to follow the pace of the customer, whether those customers are the agents or my personal clients. I am not going to starve if an agent does not have an immediate need for my services. Persistence and patience always win! Money buys patience and patience earns trust. Trust is what our industry revolves around.

Buy It As You Need It
Although you need money to make money, the good news is that you don’t have to go crazy at the outset. One thing I learned about running my own firm is that you get solicited every day. Everybody is calling you offering you this system or that system. It would eat up your whole day if you allowed it to. And some of the systems are good and you get tempted to buy. But at the outset there are certain things that you do not need, at least not until the proper time comes. For instance, one of the first systems I bought was Gotowebinar. Webinar was obviously crucial because this was how I was going to discuss my value proposition with my potential customers/agents. This was needed at the outset! On the other hand, I did not need to buy licenses in all 50 states at the outset so I didn’t. Now, however, every week I am buying a new license for a new state as a new agent from that state submits a case. Let the revenue precede the expenditures whenever possible! In other words, it’s easy to justify spending $100 to get licensed in XYZ state when there will soon be a $1,000 override check coming because of it.

So Many Reasons To Do It

• As mentioned, if you are who I described in the first few paragraphs, then building your own business is for you. Here are just a few reasons that you should run your own company:
• When you run your own business, it is very satisfying to know that every minute you work, every idea or tool that you create, is going toward the value of your company.
• You are building a legacy for your family, should they ever want to work with you.
• When you run your own company you can do business with whomever you wish. In order to run a healthy business you need to do business with those that will not be a liability to the firm—whether literally or figuratively. I have had to tell a handful of folks that I would not pursue a partnership with them for this reason.
• The upside is unlimited. I have a friend that just sold his IMO for a very large sum. I was talking to him about money. I said, “How long did it take you to make merely six-figures when you started your own IMO?” He said, “Five years.” I was hoping he would say five months! However, he then came back and said, “But I made seven-figures within ten-years and this was 30 years ago.” That is real money. Again, if you have the cash cushion and the time, it will be worth it.

Final Tip
I have been in the industry for over 20 years, have worked with many BGAs/IMOs and have learned what to do and what not to do. I have seen some awesome firms that have created their own awesome empires. I have also seen firms that have been built in an “unhealthy” manner. However, they have gotten so big that they can’t change now. In your company’s infancy, you have the opportunity to kill that monster while it is still a baby. Kill those bad habits and inefficiencies before they grow! (I wish somebody showed me the correct golf swing when I got started 20 years ago!)

Build your company the right way from the beginning by having a securities/fiduciary affiliation. Build your company the right way by being patient with your customers versus high pressure overpromise/underdeliver tactics. Build your company the right way by focusing on the relationships versus the transactions. When people do business with CG Financial Group, they do business with me personally, not the company. Don’t lose sight of that! I have seen many companies get big and have the founder get too “disconnected.” Thus, the culture that attracted customers/agents to the firm is now gone.

Lastly, build your company the right way by affiliating with other IMOs/agencies that will give you great advice. I have learned that when you go out on your own, you realize who your true friends are—those who truly want you to succeed versus those that view others’ success as a zero-sum game. As it turns out, I have many friends that have given me a lot of help. You know who you are, and I will forever be grateful.

Kids that are somewhere between the ages of five and 10 are funny to talk to. This is because they are old enough that they have become smart enough to make observations that are accurate. Yet, they are not so old that they have become politically correct. As a result, the observations they make flow out of their mouths the very second those observations register in their brains. For instance, once my family and I were on our boat at the lake and I was wearing just my swimming trunks. My eight-year old—Matthew—after giving me a curious stare for about three seconds said, “Daddy, you need to start eating at subway instead of McDonalds.” By the way, if an eight-year old tells you that you are fat, you can bet that you are indeed fat! Their worlds are so simple and non-political that they have no motives, no agendas and no reason to say anything other than what they believe to be the truth. They are still unpolluted by political correctness and 100 percent unfiltered.

However, many times the free-flowing thoughts of young kids lead to small disagreements among each other. For instance, a couple of months ago Matthew came into the house very frustrated and was crying— like he does five times a day. At that point I cynically asked, “What is the problem now Matthew?” He then went on to explain that he had just had an “argument” with his best buddy and neighbor—Blake—who is also eight years old. They have a love/hate relationship. I asked Matthew what the argument was about this time and in his chipmunk sounding voice he responded, “We were having drama over who’s dad was the strongest.” My laughter did not do much to sooth Matthew’s frustration. (By the way, I was hopeful however that Matthew pled a convincing case!)

This is analogous to what frequently happens in financial services when everybody is fighting over market share by trying to separate their product from another product. Sometimes it gets petty enough that some of us in the industry—whether carriers, IMOs, or agents—start to lose focus over the real problem that consumers are faced with today. To give an example: I have attended hundreds of conferences over the last 20 years. At these conferences, where life and annuity agents are being presented to by carriers and/or marketing organizations, it is not uncommon to hear the presenters—usually wholesalers—say something like “Because of all of these great product features that my product has, it is able to provide your clients with $20 more in distributions per year than my competitor’s product.” A lot of times this conversation is based off illustrations that are purely hypothetical and based off minute details that nobody cares about.

Another example: I recently heard a webinar that a carrier was doing for agents and this carrier was comparing how the product he was showcasing was superior to the competitors’ products because of the way that the “loan arbitrage,” as he put it, was much more aggressive. He went on to state that because of the massive multiplier on his product and the resulting credit that comes from it, it would illustrate much higher distributions than his competitors. He proceeded to explain that this is because the “multiplier credit” is not the same as a high illustrated rate. What this means is that his product was effectively exempt from the AG-49 rule that mandates no more than one percent “arbitrage” between the loan rate and illustrated rate, therefore his product was better. He also went on to flex his intellectual muscle to discuss how, with his product, the frequency with which the premium is swept from the fixed account into the indexed account was better than the others. I can go on and on about what I heard. Unfortunately, this happens frequently in our business.

The question that I always ask while hearing one of these presentations—or preparing my own—is: Would the end consumers care about this and will this information help the agents write more business as a whole? If the topic is something that clients would care about, then I can guarantee that the audience (whether agents or IMOs) is going to care. Why? Because eventually that language must be spoken at the point of sale, and if you are helping formulate that language your value as a wholesaler is significant. When was the last time a consumer asked an agent how big his/her multiplier was versus his/her competitors? Or how frequent the sweep dates were versus the competitors? This never happens. These comparisons are made not at the client level, but rather at the level of the IMO and/or carrier. Why are we doing this?

Don’t get me wrong, agents need to know the ins and outs of products and “how the watch is built.” Heck, I have trained on deep product and concept analytics and will continue to do so. That is one of my differentiators as an IMO. The reason I do this is somewhat of a paradox: The greater an agent understands something, the easier it becomes for them present it simply. As Einstein said, “If you can’t explain it simply, you don’t understand it well enough.” Again, it’s an interesting paradox.

At this point you may be thinking I am contradicting myself. Allow me to explain. There is a difference between educating agents on the information they need to know and shining spotlights on very niche technical features, or features based off “hypotheticals,” in order to incite a reason for IMOs/agents to sell those products. The latter is not what our industry needs. The industry does not need “my product is better than your product,” or as I now call it, “my dad is stronger than your dad.” What the industry needs is the training that agents care about and the language and solutions that clients demand. This is much more important than “my product is better than yours.” I don’t believe that any agent in the industry would say that he/she has the problem of not having good products to represent.

The above is why at my company/IMO we create content based off two points of view, which I will share with you:

1. Client up: This is where we put ourselves in the clients’ shoes and think about what would interest them. What clients care about is living out their retirement dreams, not outliving their income, hedging tax increases, understanding this complicated world of finance, trusting their agent/advisor, etc. Again, by creating content from the mindset of a client, agents can not only use effective content but also speak the language that clients seek. By the way, this is also why I personally produce—to be on the front lines so that I can continue to understand the needs of the clients.
2. Agent down: Here we put ourselves in the minds of the agent. The typical agent wants to learn practice management, simplification, marketing practices, behavioral finance, how to be better at building trust with the clients, etc.
   

A couple of months ago I saw a video clip on LinkedIn of two antelope fighting in the desert of Africa. The video went on for about a minute that showed these two scuffling about in circles and knocking heads. What was the issue they were disagreeing about? Obviously, I have no clue. However, I can guarantee that their disagreement was not as severe of a problem as what was approaching them from about a mile out. As they were distracted bickering with each other, what started out as a tiny speck in the background was quickly getting larger and closer. It was a lion! By the time they pulled themselves out of the distraction it was too late—at least for one of the antelopes. Unfortunately, the ending was not a happy one for that antelope.

We as an industry should not be like Matthew arguing with Blake. Or antelopes fighting with each other. We need to address the bigger issue—the lion. To me the lion represents the millions of households that don’t have life insurance, long term care insurance or savings for an adequate retirement. To me, the lion represents the fact that over a third of all households would feel an adverse financial impact within one month of the death of the primary wage earner. To me, the lion represents the fact that the number one reason people do not buy life insurance is because they believe it is too expensive, while at the same time they have misperceptions about exactly how expensive life insurance really is. Educating each other on how to have these conversations effectively is how we address the lion. That should be our focus.

Now please excuse me—because I must go arm-wrestle Blake’s dad.

In part one we discussed the differences between traditional fixed UL and IUL—with UL the general account yield generates an interest credit to the client, whereas with IUL the general account yield is instead used as a call option “budget.” We also discussed the expenses within UL and IUL. With this column we dive into the details about the call options strategy that is purchased with the options budget.

Hypothetical Product Design
The most prominent FIA and IUL design is an annual reset, point to point, with a cap design. Meaning, if a product has a cap of 10 percent on an IUL and the market goes up five percent over a year, the client gets a credit of five percent. If the market goes up 15 percent over a year, the client gets a credit of 10 percent. If the market plummets 40 percent, the client gets a zero percent credit. Of course, with all these scenarios the “big three” of expenses is deducted as well. This product design is what I use in my explanation below.

With this structure, carriers typically do not just buy call options in order to give the client those product attributes. Rather, they buy and sell call options. The “buying and selling” of call options is the bull call spread strategy that I will discuss in a bit. But first, let’s discuss options in general.

Options Explained
Options are a subcategory of derivatives. Derivatives are contracts whose value depends on an underlying asset. Examples of derivatives are futures contracts based on oil, collateralized debt obligations based on company debt, and call options based on a company’s stock or an index. In other words, the value of “derivatives” is “derived” by an underlying asset. The derivatives that we want to focus on in this column are call options on the S&P 500 Index.

The definition of a call option is: The right but not the obligation to buy an underlying asset at an agreed upon price (Strike Price) by a certain point in time (Maturity Date). With indexed annuities and IUL, that “asset” is usually the S&P 500. (Note: There are many indices that can be used in indexed product designs. There have also been many new volatility-controlled indices that have come to market. However, the S&P 500 is the focus of this column because of simplicity and prominence.)

Options are also generally separated by American style call options and European style call options. The style that is most prominently used with IUL is the European style that can only be exercised when the option matures. Naturally, if the IUL product the carrier is hedging is an annual reset design, then that carrier would buy (and sell) options with a one year maturity.

So again, with a one year maturity, at the end of that one year period the options expire worthless (if the market is flat or drops) or worthwhile (if the market increases and the option is exercised). Our $430 that the carrier is allocating to the options strategy can be 100 percent decimated if the market drops. This is why options are extremely risky. The tradeoff is, however, that options have huge upside leverage that allows the carrier to take only $430 to link the client’s entire $10,000 to the S&P 500. Below I explain more.

What in the World is a “Bull Call Spread?”
First the carrier needs to purchase a call option that will give the client’s $10,000 the upside of the S&P 500.

Well, based off the S&P 500 being at 2,670 today as well as the pricing characteristics of call options today (strike price, volatility, interest rates, etc.), a call option on a “notional value” of $10,000 will cost the carrier seven percent or $700**. By purchasing this call option on a notional value of $10,000, this means that if the S&P 500 goes up 15 percent, per the example in chart 1, then the company would get $1,500 to pass through to the client. By the way, a $1,500 gain on only $700 in options demonstrates the huge upside leverage that options have. Furthermore, if the market went up 20 percent or 30 percent, then the option purchaser (carrier) could get a relatively massive $2,000 or $3,000 gain respectively. Again, however, the tradeoff is that with options you also have a relatively high probability of losing all your $700, i.e. the mudhole.

Remember that the agreed upon price that we would buy the asset (S&P 500 in this case) for is called the “strike price” and when the asset/index moves above that strike price it is considered “in the money.” You can also see above why volatility affects option prices. If the market never deviated from the dotted “strike price” line, then there would never be any payoff to the carrier nor risk to the investment bank. Thus the bank would sell the option cheaply. However, when the market zigs and zags is when it is more possible to end up “in the money.” Hence, higher option costs with higher volatility.

In our example the S&P 500 finished the year “in the money” by 15 percent. This means the carrier could get $1,500 from the investment bank. This is a good thing!

However…

At this point I know what you are thinking: “But the above is impossible because the carrier does not have an options budget of seven percent or $700! The carrier only has 4.3 percent or $430 to spend on options!” You are correct! Therefore, the carrier would actually do a second trade in addition to the original options purchase. This is where the carrier needs to sell an option back to the investment bank to “net out” to a total cost of $430 or 4.3 percent. Before we go there, let’s discuss “strike prices” some more.

The fact that we bought the S&P 500 index with a strike price of 2,670 means that we bought an “at the money” call option. Naturally, with call options, the lower the strike price, the more expensive it would be. To exaggerate, if we were to buy a call option on the index at a strike price of $5,000 (almost double the current index level) it would not cost $700 because the chances of the S&P 500 almost doubling over the next year is next to nothing. Therefore, that option would cost almost nothing because it is of no risk to the counterparty (investment bank) and is also of little value to the purchaser (insurance carrier). So, the higher the strike price, the cheaper the option; the lower the strike price, the more expensive the option.

So now that the carrier purchased the option in the above diagram that is 2.7 percent (seven percent minus 4.3 percent) beyond their options budget, the carrier needs to dial in at what strike price they should sell a call option. To put in accounting terms, they have a debit of $700 and now they need a credit of $270 to arrive at the options budget.

The higher the strike price the better from an IUL cap standpoint, because the strike price on the option the carrier sells is what determines the cap! Yet the higher the strike price, the less the credit is to the carrier to get down to the option budget. Where is that magical intersection we are looking for? In order to keep the math simple let’s assume it is 10 percent. That is, the strike price on the option we will sell is 10 percent “out of the money” per chart 2. This means that we sold an option with a strike price that was 10 percent higher than the current index level. Because the carrier is effectively not participating in any index return beyond the strike price on the option they sold, 10 percent is the cap on the IUL. Voilà! The product is now fully hedged!

In summation, by our hypothetical carrier buying an option (at the money) for seven percent and selling an option (10 percent out of the money) for 2.7 percent, the net cost is their option budget of 4.3 percent. This is how carriers arrive at IUL and indexed annuity caps. Albeit, the math with indexed annuities is slightly different as we will discuss.
(Note: Technically, based off today’s option prices, a 4.3 percent option budget will buy a cap slightly less than 9 percent. I used 10 percent for simplification. Furthermore, the options budgets vary by carrier and could be greater than my hypothetical 4.3 percent.)

Just for fun: What if the carrier instead sold a 15 percent “out of the money” option in order to provide a high 15 percent cap to the IUL purchaser? In this case the carrier of course would still purchase the $700 call option but at what price would they sell the 15 percent out of the money option? Only around one percent! Remember, with call options the higher the strike price the cheaper the option. Thus, this product design would cost the carrier almost six percent (seven percent minus one percent), which is obviously way beyond their 4.3 percent option budget.

With my example shown in Chart 1 and Chart 2 you may be thinking: “Could a carrier subsidize the options budget by imbedding additional expenses into the policy so they could offer a higher cap like the 15 percent example in Chart 1?” The answer is, to a certain extent they can. For example, there have been many innovative product features that have come to the market such as interest multipliers. These can effectively work like higher caps and many times are subsidized by higher policy charges. (Note of caution: There are, however, product and illustration regulations that put limits on what carriers can do with the creativity around product and the illustrations. This speaks to the notion that these are non-securities products. If a carrier gets too out of hand with loading up expenses to subsidize the options budget in order to get the consumers massive upside, the product will get into “securities” territory with the regulators.)

Static Hedging Versus Dynamic Hedging
A very brief note on static hedging versus dynamic hedging. What I just explained was static hedging and not every carrier does this, although I believe most of them do. Some may do both static and dynamic hedging.

In last month’s column I discussed how I love shooting precision rifles. The problem with high powered rifles is the cost of ammo. It costs a lot of money to buy precision ammo and it still is not “customized” to your firearm. So years back I said, “Why should I pay somebody to do what I can do myself when I can do it even better?” So, I bought the ammo presses, dies, the projectiles, etc., and I started making my own ammo. I have saved money over the years and I have also been able to customize my ammo.

Some carriers feel the same way about their hedging as I do about ammo. These carriers might say, “What can the investment bank do that I cannot do?” and hedge the indexed products themselves without the bull call spread. This is called dynamic hedging. When a carrier buys and sells the options like I’ve related, that is “static hedging.” There are positives and negatives to both.

Why the Difference in IUL and Indexed Annuity Caps?
Many people have asked me how IUL policies are able offer double digit caps while annuity products are offering four to six percent on the design we discussed. The primary reasons are:

Usually IUL is priced as a “portfolio rate” product where the blended general account yield is what determines the pricing. Conversely, indexed annuities are typically priced with “new money” interest rates. This allows for more yield “horsepower” to be available for IUL than with indexed annuities because, as we discussed, new money has been paying less than general account portfolios. This may change when interest rates start increasing.

IUL carriers don’t depend as much on the general account “spread” as indexed annuity companies do because of the expense levers that IUL companies have. This means generally higher call option budgets for IUL.

Because of the longer duration nature of IUL it is easier for the carriers to “wait out” interest rate slumps relative to annuity carriers.

General Account Yields Continue to Decline
As we have discussed, when a client sends the insurance company a premium check for a life insurance policy the insurance company backs that life insurance liability by purchasing assets within their general account portfolio. Over time these insurance companies accumulate billions of dollars of these assets in various securities. Per Milliman, at the end of 2015, US Life Insurers’ general accounts consisted of 76 percent bonds on average, of which a large majority were investment grade corporate bonds.*

It’s not breaking news that life insurance carriers (and everybody else) have seen 37 years of dropping yields on bonds. Because of these persistent low interest rates, insurance carriers have been forced to reprice their annuity and life insurance products many times over. This is because of the resulting decreases in general account yields. To put numbers to it: At the end of 2007 the general account yield for US life insurance focused insurance companies was 5.72 percent. Only eight years later (end of 2015) that yield had dropped to 4.59 percent.* Thus, it is no mystery why caps on IUL have decreased. As a matter of fact, if you were to do our IUL math today based off of the 2007 general account yield of 5.72, you would see that caps would be in the neighborhood of around 3.5 percent higher today, all else being equal. Very substantial!

Of course, the general account yield is the “weighted average” of all the yields of the securities the insurance company has in inventory. As the bonds that the carriers bought say 15 years ago mature and are replaced by new lower yielding bonds, the company’s general account yield continues to get watered down. Here is a simplified example of the current conundrum insurance companies are fighting: If an insurance company’s general account has a “blended yield” of 4.5 percent and this year has $20 million in bonds from 15 years ago that are maturing, they must reinvest that $20 million in today’s low rate environment. The yield on the bonds that are maturing could very easily have been seven percent. It does not take a mathematician to understand that unless you replace those “old” seven percent bonds with “new” seven percent or greater bonds, the general account yield is going to continue to be watered down. So, interest rates could actually rise from here and it still would not stop the yield compression for insurance carriers.

The silver lining: There will eventually be a point of “equilibrium” where the general accounts no longer yield less than the new investments put into the general account. I am hoping we are close to that point as the Moody’s Aaa yield is not much lower than the average general account yield. The Moody’s Baa yield is actually above five percent, which is more than the average general account yield of 4.59 percent.

Dropping general account yields is not just an IUL problem, this is a term problem (increasing prices), this is a GUL problem (increasing prices), this is a whole life problem (decreasing dividends). In the end, the value of all these products is relative to what else is out there, and the value is still unquestionable. After all, prevailing interest rates have also dropped the rates of savings accounts, certificates of deposit, money market accounts, etc.

Insurance companies are faced with an unprecedented 37 year dropping interest rate environment and as a result they have been forced to adjust the pricing on policies as well as discontinue products. Not because they wanted to, but because they have had to.

In Closing
The magic that these products provide, whether life insurance or annuities, lies in the mortality and longevity credits. With life insurance, if one dies prematurely, there are thousands of other insureds in the insurance pool that pay for the death benefit of the deceased that could equal multiples of the premium the insured paid. Ben Feldman would discuss that with life insurance you can purchase “dollars with pennies.” With annuities you have the opposite: If you live until the ripe old age of 110, those in the “pool” that passed away early bought the “longevity credits” that guarantee you lifetime income.

Mortality and longevity credits are what make these products special. By the way, the potential tax benefits of life insurance and annuities are kind of nice as well!

References:
*Milliman: Investment strategies of US Life Insurers in a low interest rate environment.
** https://www.barchart.com/stocks/quotes/$SPX/options?expiration=2020-01-17)

My wife, kids and I went to a Christmas party at a friend’s house this year where about eight other families were in attendance. As I was standing with a group of the “Dads” talking about sports, kids and other small talk, my friend Ryan, who was standing across the room, completely changed the topic and said, “Charlie, so how much do I need in 20 years when I am 65 years old to retire so that I get say $100,000 a year forever?” As you can imagine, the other Dads left the conversation like rats from a burning barn because they knew this was going to be a long conversation. After the dust settled, I responded to Ryan: “Well, it depends on a lot of different things-like what inflation will do between now and 20 years from now, what you will get from Social Security, if you have a pension, etc.” He then looked at me with disappointment like it was a complete non-answer. So, I took the opportunity to opine some more and said, “However, there is one thing that will affect the amount of money you need at retirement in order to get X dollars in income and it is your mindset about annuities.” With a sour look on his face he then asked me what I meant. So, I responded, “Well if you don’t believe in annuities and just have stocks and bonds and follow one of the withdrawal rules that some of the pundits have created, then you will likely need more money than if you otherwise believed in annuities.” Now this last statement confused him, as I knew it would. I also knew he would get a little defensive because he is a believer in the “do it yourself” stock and bond approach. I hear that many people decided to trade these via brokers similar to Stocktrades. So it would be worth learning more from them. So, I then asked him if I can demonstrate on a couple of napkins what I meant by that. He happily agreed. After all, it was he that asked the question in the first place!

Here is the rest of the conversation that I had with Ryan. However, I will now have this conversation with you, the reader, in the same manner, instead of narrating my Christmas party conversation.

Napkin Demonstrations for Ryan
To demonstrate my point about annuities, let’s simplify this and say you are 63 years of age and you want to retire in two years at age 65. Let’s say that you have saved $1,000,000 in a stock/bond portfolio that you want to use to provide income in retirement. First, you have to know the different types of annuities and how they can help you. What would you expect that portfolio value to grow to between now and two years from now when you plan to retire? In other words, what is a not too aggressive and not too conservative growth rate we can assume on a 50/50 portfolio over the next two years? Let’s assume five percent per year that you “might” get on that portfolio. Again, keeping it simple and not including compounding, let’s say that means the portfolio will grow to $1,100,000. (See Diagram 1)

Now, at that point in time, you will retire and withdraw a certain amount from your portfolio. What percentage should we withdraw where we are confident it will last 30 years? Not an easy question, right?

The Bengen Four Percent Rule
In 1994 a CFP from California named William Bengen created what would become the “Gold Standard” of withdrawal rate rules of thumb. Bengen basically said that even though, over time, the market had averaged around 10 percent, that doesn’t mean that a client can “safely” withdraw 10 percent from their portfolios in the distribution years. So what William did is he back tested a 50 percent stock/50 percent bond portfolio over rolling periods of time starting in the 1920s. After the analysis was said and done, he said that consumers were “safe” by withdrawing four percent of their initial portfolio value per year adjusted for inflation thereafter. Obviously not 10 percent. By “safe” what he meant was that the four percent distributions were very unlikely to spend down a retirement portfolio before the end of a 30-year retirement. As a result of this study, securities reps, RIAs, IARs and do-it-yourselfers for over two decades have been living and dying by this rule.

However, in recent years the four percent rule has been brought into question as a result of the market volatility and low interest rates. Morningstar, for instance, released a study after the financial crisis that indicated 2.8 percent as the new WD rate. Regardless, let’s stick with four percent as our “rule of thumb” because the math still demonstrates my point.

That means that “assuming” the portfolio grows by five percent per year (not compounded) over the next two years and “assuming” that the four percent is in fact “safe,” you should be able to take $44,000 per year (adjusted for inflation) for the rest of your life. (See Diagram 2)

However, none of this is guaranteed! The portfolio could drop 20 percent; one could live 40 years in retirement, etc.

So, what happens if the portfolio drops by 20 percent over the next two years as opposed to our first example? $800,000 times four percent means that you are getting only $32,000 or a $12,000 pay cut relative to what you thought you were going to get. (See Diagram 3)

Unfortunately, our “ideal scenarios” and reality do not always match, as many folks retiring in 2008, 2009 and 2010 experienced.
Let’s look at a possible alternative.

Basic GLWB Explanation
Many products and riders are different, but here is just a simplified example. What if I told you that the $1,000,000, from an income value standpoint, would not grow by five percent per year over the next two years, but would grow by a guaranteed six percent simple over the next two years-which would give us an income value of $1,120,000. Then, at that point in time, you would be able to withdraw not four percent, but five percent of that value for the rest of your life, guaranteed. By the way, did I mention the word guaranteed? That means that no ifs, no ands, no buts, you would be able to get $56,000 per year for the rest of your life. Versus the $44,000 that was the “ideal scenario” or $32,000 that was the “-20 percent scenario.” (See Diagram 4)

This is the value of annuities. In this example you’re guaranteed the growth on the income value of six percent, and then you’re guaranteed a payout factor which is five percent.

Explaining the Income Value/Benefit Base
Something that many agents have a hard time explaining is: “What is the income value?” Here is the way I explain it:

Let’s take an example of life insurance. Let’s say you have a cash value life insurance policy. There are two primary values with cash value life insurance-a small value and a big value. What is the small value? That is your cash value. That is essentially your money free and clear, outside of potentially surrender charges if it is universal life.

What is the big value? That is the death benefit. Well, for somebody to get that big value/death benefit, something must happen right? Somebody must die. That is the rule the insurance company has set for somebody to get the larger value that the insurance company is offering them.

Well, annuities also have a small value (accumulation value) and the big value (income value/benefit base). The small value is the client’s money-outside of surrender charges-and the income value is like life insurance’s death benefit in that you can get that dollar amount, but you must follow the rules the company sets forth. For annuities that rule is that you cannot take any more out than X percent per year.

Bullish on the Stock/Bond Markets?
Now, naturally one may be thinking, “Okay, but the assumption of the stock and bond portfolio of only five percent per year between now and retirement is very conservative. I think the market is going to go up much more than that.” So, I did some simple math in order to address those that may be more bullish than my previous example. I calculated, based off the four percent withdrawal rule, how much that stock and bond portfolio would have to grow over the next two years in order to generate the same income that the annuity is guaranteeing. The answer to that question is $1,400,000. (See Diagram 5)

That is a significant growth rate requirement regardless of how bullish you are. This represents a compound average growth rate of 18.32 percent per year between now and the point that my friend Ryan hits age 65. Again, one would have to be very bullish on the stock market to not recognize the value of that $56,000 lifetime guarantee.

At this point in the conversation with Ryan, I told him that effectively the $1 million annuity is guaranteeing a level of income that would require much more money if he just utilized the stock/bond portfolio and the four percent withdrawal rate. Note: These simplified examples were for merely demonstration purposes as I would not suggest Ryan put his entire $1 million retirement savings into an annuity. Furthermore, the four percent rule assumes income inflation adjustments which is beyond the scope of this simplified example.

“Seems to good to be true”
A question I commonly get is, “If some very smart people like Bengen and Morningstar say to not withdraw any more than four percent or 2.8 percent, then how can the insurance companies provide numbers this attractive? Seems too good to be true!” Here’s the story that I credit to one of the leading retirement researchers, Moshe Milevsky:

There were five 95-year-old ladies sitting around the table playing bingo. One of the 95-year-old ladies looked up and said “This is very boring! We have been doing this for 30 years and its time to try something new. Let’s all put $100 on the table right now and whoever is still alive a year from now will be able to split the entire $500 pool.” They all agreed it sounded like fun so they each threw $100 on the table. One year goes by and the mortality tables show us that there are only four of those 96-year-olds still alive. One of them unfortunately passed away. What does this mean? This means that each of those four 96-year-olds gets $125 at that point in time, which is $500 divided up four different ways. It wasn’t even invested in anything over that year but they each got a 25 percent return on their money!

Isn’t that amazing how each of those ladies were able to get significantly more money back than what they put in? That is effectively what annuity companies do. They take the clients’ premium, pool it together, and, for those that live to be a ripe old age, those retirees get what is called “longevity credits.” Those longevity credits were paid for by those that passed away early.

Nobody ever questions the logic of life insurance. They may question whether they need life insurance or not, but they never question the thought of risk pooling and hedging mortality. So why do they question the concept of annuities? Afterall, life insurance and annuities are merely the inverse of one another.

Reference:
*Bengen, William P. (October 1994). “Determining Withdrawal Rates Using Historical Data” (PDF). Journal of Financial Planning: 14–24.

It is strange to me that I can remember odd places and events from very early in my childhood but at the same time I forget my own name occasionally. OK, I’m not that bad but I’m getting close!

One of my earliest memories as a kid was that mid-morning in January of 1986. My friends and I were excited that our third grade teacher gave us a break from studying as she rolled in a tv on a stand so we could watch a space shuttle called “Challenger” launch. We watched the whole thing until we saw something very confusing (to us kids) happen on the TV. This was immediately followed by the teacher standing up in a panic to turn off the TV. None of us in the room, except our teacher apparently, understood what happened until we got home and our parents explained it to us.

With the death of George H.W. Bush, I recently recalled another memory from a cold winter day in 1989. I was twelve years old when I witnessed my parents glued to the TV watching people in Germany chip away at what I thought was just a big stupid wall. The joy of everybody throughout the world was significant as reported by the news. My parents were ecstatic as well. I couldn’t have cared less.

It was not until years later when I realized that that “big stupid wall” coming down represented an end to a cold war that could have ended in complete annihilation of hundreds of millions of people. How did the civilized world with all that brainpower, God fearing Ivy League educated world leaders, all the PHDs, thousands of diplomats, and hundreds of millions of reasonable people, get to the position of world annihilation? Well, it all started with two super-power militaries. Then it progressed to two super-power militaries that created really big guns to outdo one another; the bigger the better! Then it ultimately became two super-power militaries with almost 65,000 nuclear warheads at the peak (1986) that could have destroyed the entire earth many times over. It only took a push of a button.

How did we get there? All of this started with some smart people simply doing a “tit for tat” in order to gain an edge over the other. This was the nuclear arms race with the Soviet Union.

Arms Race (Wikipedia): a competition between two or more states to have the best armed forces. Each party competes to produce more weapons, larger military, superior military technology, etc., in a technological escalation. The term is also used to describe any long-term escalating competitive situation where each competitor focuses on out-doing the others.

I am fully cognizant that this is a hyperbolic analogy to anything in financial services, but I know many of you love history as much as I do. Plus, there are some very interesting parallels in the nuclear arms race and what we occasionally experience in the competitive world of financial services. We have witnessed universal life insurance in the 80s, VUL in the 90s, variable annuities in the 2000s, and now IUL.

To be clear, I have built my career on annuities and IUL. I believe that IUL is a wonderful product whose birth in 1997 has greatly helped our industry and will continue to do so. I have even sold a significant amount of IUL to personal clients of mine. However, I fear that the “tit for tat” that has occurred in this space has led to an “arms race” of features over the years that is counter to what consumers care about.

Like any product, the right number of bells and whistles attached to IUL is a balancing act. Bells and whistles are good until they become too complicated for any client to understand. However, If I were to say that I don’t believe in multipliers, bonuses, higher caps, etc., then I would somewhat be questioning the very foundation of IUL which I will not do. As a matter of fact, I do believe there is a “risk premium” that a client gets in their credited interest by agreeing to sacrifice the guaranteed return that they would otherwise receive with a fixed rate product. Furthermore, I do believe there is a bit of a “risk premium” that consumers can get by paying a higher fee or charge in IUL in order to get more upside via a multiplier. In short, if I were to say, “Lets strip these things down to as vanilla as we can get,” then I would be saying that we should just go back to selling only current assumption fixed rate UL. That is the furthest thing from my belief, although I like fixed UL!

Our whole financial system revolves around the notion of “risk premium.” Meaning the more risk you take, the higher the expected return. A simple and probably the most prominent example would be the long term returns of stocks versus bonds. The famous Ibbotson Stocks, Bonds, Bills, Inflation Chart very clearly shows this notion of the more risk you take, the more gains you should experience over the long run. Reflected in the chart is 100 years of history showing the direct relationship between risk and reward.

So again, for me to say I don’t believe in these recent innovations on IUL and the “risk premium” notion, then I would also be questioning something that our financial system revolves around. Or, back to my cold war analogy, it would also be like me saying that I don’t believe we should have militaries and I don’t believe militaries should have big guns. If you know me personally you would know that, again, these are things I would never utter. However, like anything else in life, the situation can get blown out of proportion and get nuclear.

An example of “nuclear” would be this: A carrier, distributor, or agent selling a product based off the size of the distribution numbers on the illustration and comparing those numbers to the other products’ illustrations. Then, who wins this “arms race” depends on who illustrates the largest distribution numbers. Then, over time those distribution numbers get inflated by carriers increasing caps for higher max illustrated rates because that is all that would be sold. Then when max illustrated rates get capped out because of AG49, additional product features, which many times bring additional expenses, get introduced that circumvent the AG49 process. As if illustrating a 50 percent profit on the call option budget year after year was not enough! Note: If a carrier invests say, four percent of the premium in options but illustrates a six percent credit to the client year after year, that is a 50 percent return on the option strategy. Why aren’t institutional money managers doing this with their money?

To copy a meme that I saw on Facebook a while back, “Do you want an arms race? Because this is how you get an arms race.”

The above is unfortunate because these products work at the client level without the arms race. They work by having death benefits that are multiples of the premium many times. They work because they have potential tax advantages. They work because they have a savings component. They work because they have wonderful long term care/chronic illness benefits! They work because of the time value of money!

As I posted on LinkedIn recently, I have yet to have a client say to me, “I want an indexed universal life insurance contract that is uncapped, volatility controlled, low premium loads, and also has the highest interest rate multiplier.” I have, however, had clients ask about the death benefit on life insurance, the potential savings component that can be tax free on life insurance, and possibly long term care benefits that can be added to life insurance. Consumers couldn’t care less about this arms race and who wins it! So why do we?

To me, all these products are good for the right consumer. To me, it depends on the level of understanding a consumer has about the product they are buying. My belief is that an astronomically complicated product sold to a consumer that 100 percent understands that product is better than the simple product sold to somebody that has no clue what they bought. As a matter of fact, I will be buying a life insurance product soon that does have a large multiplier that is “uncapped” and that is complicated. But that’s OK because I understand the product and understand the risks. Furthermore, to me the risk of higher expenses I believe will reward me via a “risk premium” ultimately.

If there was blame to go around for this arms race and the potential consequences that may come, the blame cannot be pointed at any one entity, whether it be the carriers, the regulators, the distributors, or anybody else. For example, one can’t blame the carriers for developing these products. After all, if a carrier developed a product without these features which in turn would look bad on illustrations, it will not sell relative to the others. If their product sells to zero customers than it is zero customers that have been helped! Not a noble cause. Plus, the company would go out of business by not selling that clean and simple product they created.

Conversely, distributors should not be blamed for the arms race because I have seen the marketing from some of the carriers that very much pitches multipliers, high caps, high illustration rates, etc. More education is needed from the carriers discussing how these multipliers are funded.

This arms race is a function of competition. But competition is good as it allows capitalist economies to provide the best products and services to the consumers. This is a tough conundrum.

During the nuclear arms race with the Soviet Union there were very few certainties. However, and fortunately so, there were two things for certain: First off, the nuclear arms race had a very clear and understandable magnitude of potential consequences which kept everything in check—100 percent annihilation. In other words, there is a military strategy called “MAD” or “mutually assured destruction.” This strategy says that we understand our competitor can destroy us, but we can do the same to them. And as soon as their button is pushed, so is ours. And our button is just as big is theirs. Pretty good deterrent I would say. The second certainty in the cold war was: There were buttons! They knew with 100 percent certainty what the point of no return was, which was the push of a button. Both sides clearly knew where the line was, and they also knew the consequences of crossing that line—i.e. pushing that button. Therefore, they never crossed that line.

In this less intense arms race we do not have the benefit of having a button to know what not to push. We do not know what the “mutual destruction” or possibly “mutual regulation” looks like that we could ultimately inflict on one another. Does “mutual regulation” mean something benign like additional disclosures? Or will it mean something like NASD 05-50 and SEC 151a where these products will be treated like securities? Will it mean something like a BIC Exemption if/when DOL part 2 comes around? Or could it mean something more on the “destructive” side where IUL takes the same path that VUL did over the last 20 years, where the product line went from over 30 percent of total life sales to only seven percent today.

None of the participants in any arms race enjoy it. I believe that if you had a room full of 100 executives from insurance carriers and distributors that were asked what they would prefer between the two options below, that a large majority of them would choose option A:

Option A: To reset the clock to a time when the sales were not about the illustrations and the illustrations were not about the size of the numbers but rather about making everything transparent to the consumers. To sell the product based off the “non-spreadsheet” benefits like the power of the death benefit, the value of tax-free distributions, the value of having a hedge against a long term care event. If this means tapping the brakes on this “proliferation” of multipliers and mathematical crediting equations, then so be it.

Option B: Continue with the way we are doing it.

I believe the industry and all its brainpower wants Option A. But, at the same time, who will be the first through the door while the others continue with the arms race? Is it carriers? Distributors? Agents? Which carrier? Which distributor? Which agent? Of course I am speaking in generalities, because there are already a few out there within each category. Just not enough.

I am for Option A. I believe it all starts with the end consumer and that should dictate the message up the entire distribution chain. As I alluded to, I have never heard of a consumer ask for comparison on the distribution amounts from my illustration versus another carrier’s illustration. The consumers want to know three things: 1. Do they trust you? 2. Can you educate them on what they are buying? (Or verify the information they already got on the internet?) 3. Will this solution give them and their family the financial lives they desire, whether at retirement or in the event of a tragedy?

Having seen and experienced the escalation of the previous arms races that ended in product closures, bad press, NASD 05-50, SEC 151a, etc., I am starting to get a similar feeling. I am hoping that we, as an industry, will find a solution to this before the proverbial “button” is pushed.

“The nuclear arms race is like two sworn enemies standing waist deep in gasoline, one with three matches, the other with five.”—Carl Sagan, Astronomer