IUL: Mutually Assured Regulation

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

Charlie Gipple, CLU, ChFC, is the owner of CG Financial Group, an innovative and full-service independent marketing organization (IMO) that serves independent agents that sell life insurance, annuities and asset-based long term care. He also owns “The Retirement Academy” (www.retirement-academy.com), which is a subscription based online training platform for agents, reps, and company wholesalers.

Gipple is recognized throughout the industry as one of the foremost thought leaders and subject matter experts on annuities, life insurance, long term care, leadership, storyselling and behavioral finance. He is also an industry keynote speaker conducting 100-150 speeches per year. He has spoken at the MDRT Top of the Table as well as other large forums and has also appeared on TheStreet.com and AM Best TV.

Gipple has vast leadership experience in the insurance industry as he has been an executive of various insurance companies and large independent marketing organizations. He is unique in his broad knowledge across the life insurance, annuities and securities businesses. Additionally, within these businesses, he has a deep understanding of the distribution aspects of these products along with the actuarial and hedging aspects. He holds a bachelor’s degree in Finance from the University of Northern Iowa, is FINRA Series 7 and Series 66 licensed and also holds the CLU® and ChFC® designations.

Gipple can be reached by phone at 515-986-3065. Email: cgipple@cgfinancialgroupllc.com.