Life insurance can be a simple but effective financial planning tool. Term life insurance provides temporary coverage, usually for a specific number of years, as long as premiums are paid on time and the policy is not cancelled.

Permanent or cash-value life insurance, which provides lifetime coverage, comes in four basic flavors: whole life, variable life, universal life, and variable universal life.

Indexed universal life insurance (IUL) policies, a relative newcomer to the permanent life insurance market, has seen tremendous growth since the first IUL policy was introduced in 1997.

Your financial planner has probably pitched this coverage to you at some point.

IUL policies are extremely flexible for retirement planning, estate planning, educational funding, and business planning (buy-sell agreements, key employee plans, and executive bonuses), among other applications.

Currently, 25 carriers offer IUL policies. These policies are US-state specific and are not available in all states.


As with traditional universal life insurance policies, IUL policies are desirable because of the flexibility in premium payments and death benefits, the low cost of the life insurance, and the tax-deferred growth of the cash values (with borrowing ability via loans and the tax-free death benefits).

The IUL’s policy chief differentiator gives you the ability to participate indirectly in the upswings of the stock market without having to accept the associated downturns.

The interest credited to the policy’s cash value is determined by the annual changes in an equities index, a diversified collection of stocks whose performance is representative of the overall movement of the market as a whole. The most commonly used index is the S&P 500.

A portion of any premium paid is used for insurance costs. The remainder minus any policy-related charges are credited to a tax-deferred cash account. A fixed crediting method—or an equity-related index crediting method, or both—is applied to the cash values.

The general principle underpinning IUL policies is that when the index increases, the cash value of the policy also increases to a maximum limit or growth cap set by the insurance company. Thereafter, the new cash value is locked in.

As IUL policies do not directly invest in equities, downside risk is minimized. Instead, the insurance company assumes the risk with these policies. When the index is flat or loses value, most products guarantee that the interest crediting rate will never be less than zero. A minimum guaranteed interest rate is applied to the policy, preventing a decrease in the cash value despite fluctuations in the S&P 500.

Some companies may offer a cumulative guaranteed rate, ensuring a minimum effective rate over a given time period. IUL guaranteed minimum interest rates are almost always lower than those found in traditional universal life policies.

Traditional universal life policies offer a minimum guaranteed cash value crediting rate. Variable universal life policies offer greater potential gains depending on investment performance, but no protection against downturns in the market. IUL policies are an attempt to bridge the gap between the relatively safer traditional policy and the riskier variable policy.

What are the disadvantages of an IUL policy? For one, it has a slightly higher risk than a traditional universal product. Additionally, the growth cap limits the upside potential possible with a variable product, and the issuer may change the cap rate periodically.

Are you a candidate for an IUL policy? The answer would be yes if permanent life insurance is suitable in your particular situation, the potential cash accumulation of variable life is enticing but risky, and the guarantees of universal life are comforting but seem insufficiently low.

See also “All About Insurance” by Cheryl Whitman in the June 2006 issue of PSP.

On the horizon, new IUL policies will offer minimum guarantees of up to 3%, rate caps of up to 17%, interest crediting linked to different indexes, higher target premiums, and enhanced living benefits for long-term care and critical illness. These second-generation policies will likely add to the choices and popularity of the IUL policy.

Mervin Low, MD, CWPP, CAPP, is a plastic surgeon who practices in Southern California. He also is a certified wealth-preservation planner and a certified asset-protection planner. He can be reached at .