A small bright star: indexed universal life insurance was the fastest-growing product line in the individual life insurance galaxy last year, and specialists expect fast growth to continue.

The newest star in the life insurance universe-based on sales growth, at least--is indexed universal life insurance.

According to Advantage Compendium, the St. Louis-based research and consulting firm, sales in 2006 rose to $352 million, up by 89% over those in 2005. The big gain came after years of muddling along with minimal sales and slow growth.

Last year's performance doesn't mean the indexed life product is about to change the face of life sales. In terms of premium, it still holds only a small fraction of 1% of the industry's total annual individual life insurance sales. As reported by the Insurance Information Institute, total individual sales in 2005 were about $109 billion.

The growth spurt, however, serves notice that indexed life writers and producers are increasingly comfortable with the product designs, and the product is likely to attract more attention from consumers.

Several factors are driving the surge in indexed life sales. At a conference presentation in April, Dale Visser, a consulting actuary with consulting firm Milliman Inc., said insurers have been able to leverage their experience with equity indexed annuities (2006 premium of more than $25 billion) to acquire the hedging knowledge and infrastructure necessary for indexed life. That includes dynamic hedging, which potentially reduces costs. These abilities have led to more product designs that can illustrate well to prospects. Meanwhile, a major influx of carriers into the market since the third quarter of 2005 has brought the number to 23, according to Advantage Compendium, and Visser predicted about six more carriers would enter this year. Only 10 companies offered the product at the end of 2004, he said.

Simple Appeal, Complex Product

Although the working parts of the products are complex, the concept is simple. Like their annuity cousins, indexed life products credit interest based on the performance of one or more stock indexes, and they guarantee that owners who stick to the rules will not lose money. "There are people who want the downside guarantees, but they want a higher upside potential than in a traditional fixed UL product," said Sheryl J. Moore, president and chief executive officer of Advantage Group Associates Inc., a research and consulting company, and AnnuitySpecs.com. "Indexed universal life is the perfect product for this market segment." The fact that major carriers are jumping in adds legitimacy to the product line, Moore said.

Introduced prior to 1998, indexed life products traditionally have been used to accumulate cash and potentially raise the death benefit. Owners planned to tap the cash value for supplemental retirement income or education funding. But six carriers currently offer an extended no-lapse product similar to no-lapse UL, said Moore. Among permanent life products, these provide the most insurance for the lowest premium.

Visser characterized the secondary guarantees as stronger than those in variable universal life, but weaker than in universal life. He predicted the guarantees would become increasingly competitive.

Product design, in fact, has played a major role in last year's sales surge. Many design improvements have helped distributors become more effective, Moore said. A design that is "really catching on" is variable loan interest rates, which help producers illustrate potential benefits, said Moore. Owners access cash values by loans, and in many permanent products, the net cost of a loan is little or nothing. However, writers of indexed life have been able to illustrate outright gains to a prospect. Moore offered the following example: A company illustrates a credited rate of 8% and assumes a variable loan rate of 6%, yielding a positive 2%. "On paper, that's all good and fine, but you may not get 8% credited," she said. "You may only get 4% or 0%. And your variable loan rate may actually go up to 9%. So you could actually end up being upside down on your loan, but at the point of sale, the illustration looks fantastic, and agents really like that."

Moore said Aviva, which bought AmerUs Life Insurance Co. last year, was the innovator in offering variable loans. In April, Lincoln Financial Group capped its variable loan rate at 5%--an unprecedented move, she said. Others have capped the rate in the area of 9.5% or 10%, she said.

Strong Recent Performance

Also contributing to sales growth is that many IULs illustrate very well versus other products since 2000. While many variable universal life insurance owners, for example, recorded big losses in the stock market drop from 2000 to 2003, IUL owners recorded no losses or even small gains. And while the low-interest-rate environment hurt returns on fixed ULs, IULs were crediting higher rates derived from their links to the stock indexes. Moore said many policyholders have been "absolutely thrilled" with returns of the past few years. Of course, not all periods will provide good comparative returns for IULs, and both Visser and Moore noted some IUL writers are "cherry picking" their illustrative historic periods.

Guaranteed withdrawal benefits, which have taken the variable annuity business by storm, had not debuted in indexed life as of May, but Moore said at least a couple carriers intend to launch them this summer. "I'm also aware of some super-competitive provisions that will turn the entire UL industry upside down, not just the IUL industry, as far as benefits that will revolutionize the industry," she said. "I can't release too much more, but I will say it's from somebody who is already in the IUL industry, and it's a benefit the likes of which you've never seen." Players in the VUL and UL industry will copy this benefit, she added.

More Product Features

Four carriers as of April offered "rainbow" crediting methods, according to Visser. This involves use of more than one index, such as the S&P 500 Index, the Dow Jones Industrial Average, the Nasdaq 100 or an international index. Insurers then credit the greatest percentage from the best-performing index and correspondingly lower proportions of the others. One example of a writer enjoying "quite a bit of play off of this" is AIG American General with its Elite Global IUL, said Moore. It credits 75% of the return from the best-performing index, 25% from the next best, and 0% from the third index it uses. Aviva also uses rainbow crediting, she said. The method is too new to determine whether it is outperforming products using a single index, she added.

Three other features have emerged, said Moore. Allianz has launched a return-of-premium product. Five single-premium products have appeared; these can be sold as an alternative to an annuity sale, she said. And there are indexed survivorship universal life products that are strong competitors to traditional SULs. Aviva, in particular, has brought in some big survivorship cases, she said.

The Aviva group of companies, including AmerUs Life, Indianapolis Life and Bankers Life of New York, leads the industry in sales. Executive Vice President Brian J. Clark, the chief product officer, said a key factor was a change in product design many years ago that stretched the minimum annualized 3% crediting guaranteee from one year to five years. This reduced costs and allowed AmerUs to offer to the customer higher upside potential from the indexed crediting strategy. "Nobody copied us for four or five years after we did that," he said. Now he estimates that 70% to 80% of the market has taken this approach. AmerUs' guarantee is currently 2% annualized for the earlier of five years or policy termination, he said.

In recent years, Aviva products have performed much better than the 5% or so crediting rate in traditional UL products. For index-linked premiums that ended their five-year segment period in last year's fourth quarter and this year's first quarter, the average credit ed rate came in at 7.6%, said Clark. Aviva's guideline illustrated rate for a product with an 11% cap--based on a study of the S&P 500 index from 1950 through 2006--is 7.55%.

Aviva's lineup includes cash-accumulation oriented products, a death-benefit product with a no-lapse guarantee rider, a whole-life type of product, a survivorship product and a single-premium product.

Key Points

* Agents and consumers have started to notice that indexed universal life products can deliver better performance than traditional UL without market risk.

* The number of indexed universal life writers has more than doubled since the end of 2004.

* In many products, the minimum guarantees are no longer credited annually. Many are credited retroactively after five years.

How Indexed Life Products Work

Although the many indexed life insurance products available today are diverse, they share some common elements. Like indexed annuities, they credit interest based on the performance of one or more external stock indexes. Crediting methods vary. The most common are:

* Annual point to point. To determine the interest rate, subtract the beginning-of-year index value (B) from the end-of-year index value (A), and divide by the beginning value (B).

* Monthly averaging. The (A) minus (B) divided by (B) calculation is also used for this method. However, the average of the 12 monthly values of the index is used in the calculation (A).

* Daily averaging. Same as for monthly averaging, but uses each day the market is open for the averaging calculation.

* Monthly point to point. This is a misnomer, as this is actually an averaging strategy. A more accurate description of the method is "monthly sum." The index's performance is calculated and tracked each month, but potential interest is not paid until the end of the 12-month period. Contracts apply a cap to monthly gains, but no protection is given against a monthly decline in the index. For example, if the index experienced monthly growth of 5%, but there is a 3% cap, 3% is recorded. However, if the index experiences a decline of 20%, that is the amount recorded. If the end-of-year sum is negative, the insurer credits zero. Some agents do not understand there is no monthly downside cap with this strategy.

Insurers also provide minimum guarantees. Many of these are different from the annual guaranteed return of 2% or 3% in traditional universal life products. One insurer, for example, has minimum annual guarantees of 0%, but if after five years the gain in the contract falls short of the equivalent of at least 2% compounded annually, the company will credit enough to make up the difference.

Other examples: One insurer guarantees 0% annually, but will true up the amount to 3% in the event of death, lapsation, policy surrender or maturity. Another insurer guarantees 0% annually, 2% on its fixed strategy, and 3% cumulatively on surrender. Newer contracts are trending back to the guarantees first used on indexed life products and guarantee 1% annually regardless of circumstances.

Annual point-to-point crediting methods come with annual caps that are currently around 11% to 15% for many of the strategies. Most monthly and daily averaging methods come with no annual caps. Their participation rates can exceed 100%; some are as high as 140% currently. Monthly point-to-point caps are presently around 3.2% to 3.5% monthly for most contracts.

Source: Sheryl J. Moore, president and CEO of Advantage Group Associates, Inc.

Learn More

AmerUs Life Insurance Co. (Aviva USA Group)

A.M. Best Company # 06199

Distribution: Career agents, personal producing general agents, independent marketing organizations

American General Life Insurance Co. (AIG Group)

A.M. Best Company # 06058

Distribution: Personal producing general agents, brokers, independent marketing organizations, agency system

For ratings and other financial strength information about these companies, visit www.ambest.com.

Advantage Index Product Report-First Quarter 2007

                           1st Quarter   % Change   % Change    Market
Company                           2007       4Q06       1Q06   Share %

Aviva                      $32,267,620      -12.8       16.9      31.2
Aegon Cos.                  12,596,232       22.7       66.5      12.2
AIG American General        12,000,000        5.9        5.9      11.6
National Life Group         11,007,490        9.4       49.6      10.6
Old Mutual                   8,576,305       45.3        0.7       8.3
Pacific Life Cos.            7,965,399       43.5       58.6       7.7
Allianz Life                 5,742,000      -16.8       97.8       5.6
Midland National Life        5,094,000       10.0      149.0       4.9
Conseco                      2,760,133      -11.7        3.4       2.7
Lafayette Life               1,796,379       -0.5      -36.4       1.7
National Western             1,500,000       12.7      195.3       1.5
Union Central Life           1,003,342        9.6      371.5       1.0
  (A UNIFI Company)
North American Co.             879,668     1499.4        N/A       0.9
Minnesota Life                 201,510       89.3        N/A       0.2

Total IUL Sales           $103,390,078        4.4       31.6

Source: Advantage Compendium

Indexed Universal Life
Sales Soar

($ Millions)

1998    65
1999    62
2000    63
2001    86
2002    98
2003    97
2004   136
2005   186
2006   352

Source: Advantage Compendium

Note: Table made from bar graph.