By Richard Proteau:


Advice is in the end all about value. Without value there is no need for advisors.


Discover the true value of life insurance by using the only application that can do a pre-estimate of the Fair Market Value of T100 COI products


Rule 10. Thou shall never be too pessimistic even if this means showing a less attractive illustration


Let’s look at an IUL illustration. I have chosen the Phoenix Sample Simplicity illustration. In their illustration there is a section on historical returns and the impact of the IUL guarantees on the rate that would have been credited historically. Based on the analysis provided, Phoenix advocates a maximum illustrated rate of 7.25%.


But how many advisors have read the disclaimer and understand this statement: “Indexed Growth Rates exclude the effect of monthly deductions and withdrawals from the Indexed Accounts, if any, which could make these results lower.”


This is called cash drag; you know the cash drag that you so readily assigned to mutual funds to state that IUL was cheaper. Cash drag on IUL can take two forms. Either it will lower the credited rates directly as the COI is withdrawn from an account subjected to variable returns or indirectly if one year of COI is invested in the guaranteed account. Cash drag applying against a mutual fund is pretty much a constant because of the size of the fund. Cash drag on an IUL applies at the policy level and on an individual basis. Therefore cash drag will increase as the percentage of the COI versus Cash Value increases. This is another risk that the policy holder must assume at the policy level. Nowhere is this mentioned in the presentation Tax Free Money Machine.


As for Pheonix, for an insurance company, they should know better. If they want to exclude a variable, they have to use caution. Therefore the maximum illustrated should have been reduced to 7%.


This leads to the next rule.


Rule 11. If you offer a trip to Mexico to those who are selling IUL, it is your responsibility to train them and educate your target audience on all risks associated with the product


Rule 12. Thou shall not misrepresent the results in one situation to apply to a different situation.


“the problem with how IUL is presented to consumers is that the advisors who believe in this product are 50% of the times right and 50% of the times wrong. For those advisors who are against this product, they are 50% of the times wrong and 50% of the times right. I can therefore state that consumers get 100% of the times half of the story” Richard Proteau 2014 on Universal Life


When I started to criticize the way IUL were sold, many advisors became angry. On advisor stated: “if you have a product that kicked out a verifiable return of over 6.8% over the last 14 years when we had 3 MAJOR DOWNTURNS in the market and the S&P ONLY did 2.8% (DO YOU THINK THE NEXT 40 YEARS WILL BE THAT BAD?) So when we project a 7% return for the future with a CAP of 13.5% how are we doing our clients a disservice.”


This perfectly represents an advisor who is overstating the value of the Index Universal Life.


The statement of the advisor which seems strong in appearance is extremely weak. In making such statement, an advisor should always specify the time period and be extremely specific on the investment he is referring too.


Again, the investment of the IUL is based on the S&P without the dividends. From a period of December 2000 to December 2015; I get an annualized return of 2.9% which matched the advisor statement. However when comparing to an outside investment, no one would buy the Index without the dividends.  An investor buying a Mutual Fund based on the Index with dividends or an ETF would have earned 4.2% to 4.7% depending on the fund.


The advisor, by conveniently forgetting about the dividends, has overstated the value of the IUL guarantee by almost 2%. This is illegal! The IUL provided a 6.8 return versus 4.75% for an equivalent investment.


I am not disputing that the IUL is a great product in a market with major downturns. However you have no right to overstate the results.  In addition, the observation you are making has too apply to the situation you are illustrating.


In other words, you can’t assume that the 2% advantage which we observe in a bear market with severe downturns will apply to a bull market with severe upturns. Because of the CAP of 13.5%, we can make the hypothesis that there will be an equal and opposite effect and the 2% advantage will become a 2% disadvantage IN SUCH A BULL MARKET.


What is the Tax free money machine illustrating in its analysis; a bull market of bear market based on the same return? It is not disclosed. However most consumers would associate a 7% return with a bull market. In a bear market, the value of the Index  with dividends would have been 5% but in a bull market it will have been 9%; two different patterns of returns can translate into the same result.


Let’s use the advisor statement that during the last 14 years, money invested in an IUL earned 6.8% versus 4.8% (not 2.8%) if the money had been invested in an outside investment. The 6.8% is an annualized return or the average of the credited returns for the last 14 years such that if you had invested the money at 6.8% for 14 years, you would have the same amount of money at the end of year 14. But the client did not earn 6.8% every year. His annual return varied year to year. In fact, I could produce million of sequences of returns over 14 years that would result with the same cash value at end of year 14 and therefore with the same average rate of return of 6.8%. Let’s introduce some math concepts:


MIRROR sequence of returns: This is a sequence of returns that would represent the equivalent opposite of a sequence of return yielding the same average rate of return. Again what needs to be understood is that the average return of 6.8% is the result of a bear market where it is the equivalent of a 4.8% return for an outside investment because of the impact of the minimum CAP rate and mathematically this means:




F(x+1….y+13) = 6.8% where x is the sequence of yearly rate of returns where a Minimum CAP exists in a downturn (bear) market where the equivalence to an outside investment would be:


F(x+1….x+13) = 4.8% where x is the yearly rate of return and where no CAP exist


SITUATION B: Mirror of situation A


F(y+1….y+13) = 6.8% where y is the mirror sequence yearly rate of return of Situation A and where a Maximum CAP exists in an upturn market and where the equivalence to an outside investment would be:


F(y+1….y+13) = 8.8% where y is a yearly rate of return where no CAP exist


It is clear that any advisors supporting IUL sales and doing illustration at 7% such as used in the Tax Free Money Machine are selling Situation A. Those who are the detractors of IUL are using situation B. The problem is when the client is sold Situation B using the mirror sequence of Situation B (Situation A) to present and misrepresent the best of both worlds (which cannot happen).


Rule 13. Thou shall only present an illustration that has a high probability of occurring.


What is Investment divergence? Investment divergence occurs when an illustration is used with a constant return to illustrate what can possibly be earned from an investment subject to variable returns.


In the trading industry, divergence occurs when an indicator and the price of an asset are heading in opposite directions. In the case of an illustration WITH A CONSTANT RETURN used to represent the behavior of any investment SUBJECT TO VARIABLE RETURNS; the indicator is the investment selected in the illustration. Divergence occurs on the associated historical standard deviation and the standard deviation that would be required to be achieved in order to achieve the illustrated results and which is heading in the opposite direction.  (In other words your investment and constant rate of return illustrated implies a high standard deviation when in fact, the only investment that could yield the illustrated results is an investment with a low standard deviation).


When this divergence occurs, the illustration cannot translate into something possible based on the investment selected in the illustration.


I want to be clear: when divergence exists in an illustration, you are portraying illustrated results that can be achieved through the selection of a particular investment when these results can only be achieved through an entirely different investment; and in most case an investment that can’t possibly exist!!!


So what is the definition of investment divergence? It is a separation of the illustration from reality because what is illustrated by selecting a particular investment and using a CONSTANT (rate of the illustration) has changed into something different that can only be achieved through the selection of entirely different investment because the constant is in fact a VARIABLE (rate of return of the investment). It is often an investment that does not exist. You are presenting ILLUSTRATED VALUES that CAN”T TRANSLATE INTO ANYTHING REAL!


So let’s illustrate this without complex mathematics. Let’s assume Investment A with an historical return over 15 years of 8% with a maximum rate of return of 25% and minimum rate of return of 25%. This results into a deviation from the mean of + 17% and -33%. This deviation is extremely important as it restricts the number of sequential returns that can produce this 8% average return.


Now let’s assume that you are doing a retirement planning session and you want to illustrate how much money your client will have at age 65. You are bullish and you do an illustration based on 10%. What are the implications of this illustration since it is based on a 10% constant rate of return. What are the assumptions you are making on the real sequence of rate of returns which are really changing on a daily, monthly and annual basis?


There are only 2 ways this 10% can be achieved:


1) You assume that the historical maximum and minimum won’t apply in the future and therefore expecting that the client will earn for example a 30% maximum instead of 25%. Since I don’t see how you could predict this, I will remove this option from the table.


2) You are assuming an increase in the number of returns above 8% and a lesser number of returns below 8%. Remember deviation? With a deviation of -33%/17%, you need 2 years at 25% to recover 1 year of -25%. This is a 2/1 ratio which has increased because deviation is now -35%/15%. So when you are using a CONSTANT 10% illustration rate you are diminishing substantially the dispersion of the returns around the mean therefore changing the standard deviation.


In mathematics, we would state that as an illustration rate x% increases towards the maximum rate of return y%, the LIMIT of function f(x) for the standard deviation of X is equaled to ZERO. It is not that difficult to test. Let’s assume you are bullish to the extreme and you illustrate at 25% for the S&P 500. If you earn 24.999999%, to earn 25%, you would have to get at least 25.000001 which is impossible since the maximum is 25%. So standard deviation is indeed zero.


In order words, while you are illustrating the S&P 500, the only investment that could provide such a return is in fact a long term guaranteed investment locked at 25% for the projected time period. This is divergence at 100%.


How come I’ve never heard of this when selling mutual funds?


This is pretty simple to answer. For divergence to apply to an illustration based on a CONSTANT RETURN for mutual funds it would involve a high illustration rate and the mutual funds industry has been extremely good at weeding out the enchanted story tellers. This is not the case in the insurance industry. In Canada, I have recently seen illustrations done at 16% gross rate of return with AIG Canada now BMO Canada. Divergence was at play here.


Why does it apply to the Index Universal Life?


The answer is simple. The IUL has a minimum cap and maximum cap which brings divergence in the realm of the possible.


Think about this for a moment. Let’s assume an IUL with a 12% maximum cap. A client is presented an illustration at a constant rate of return of 12% using S&P500. While this is extremely aggressive, most clients would believe it is possible for the Index to provide that return (he probably would change his mind if he was told these exclude dividends).


The client would not know about divergence and that 12% illustration is an impossibility using the S&P 500. Think about it. The S&P 500 yields 11.99 in the first year. In the second year you would have to earn 12.01 to get back on track and match the illustration of 12% constant rate of return. But while the Index could yield 12.01%, you would only still get credited 12% because of the CAP. There is a 0% possibility to create of sequence of variable returns for the S&P 500 that could yield any of the cash value at any points represented by the illustration created using a constant rate of return..


The law of divergence for illustrations based on a constant return to illustrate an investment subject to variable returns: As the constant illustration rate moves toward the maximum CAP, the standard deviation of the investment that could yield the illustrated results is getting lower and lower.


When should I be concerned about divergence on IUL?


My rule of thumb is 50% of the maximum CAP. So if the CAP is 12%, anything above 6%, includes divergence and if your cap is 13%, then it is 6.5%. To compare the 2 product using illustrations of equal probability, the first illustration would be based on 6% and the second one on 6.5%. Since I would make the assumption that the product with a 12% CAP is cheaper, the question is whether if the lower COI of the first product would offset the difference in the illustrated rates.


You do not compare illustrations of different probabilities without the appropriate adjustment.


Negative divergence also applies….


What we talk about so far has been positive divergence. Divergence also applies to the use of the minimum CAP. In the Time money machine analysis, we see that at 5% the cash value disappears. But is this a probable risk?


Again, let’s assume an IUL with a 12% cap and 0% cap. We have an advisor who is extremely conservative and want to educate his client on risk. He does an illustration at 1% constant rate of return.


Imagine for one instant the dispersion of returns implied with that 1% constant rate of return. For example, in the first year, the S&P makes 15% and the client get 12%. To match the 1% constant rate of return of the illustration, the S&P 500 would have to credit 12 years of consecutive returns below 0%. Two years of good returns above the max cap, would require 24 year of consecutive returns below 0%. This is not possible.


So again as you move the constant illustration rate towards the minimum CAP you are in fact implying that the standard deviation of the S&P 500 is getting lower and lower reaching 0 if the illustration was done at the minimum cap rate.


How do I explain this to the client?


Well good luck with this. But first I would study this and know what I am doing because this is your problem, dumbass. Yes I am calling you dumbass if you are an advisor or are working in the insurance industry because this is the only adjective I can find to quantify the stupidity of an industry in wanting to represent the rate of an equity investment which is a variable as a constant.


The insurance industry only has to make a simple change to the illustration software to generate variable sequence of returns, then there would be no divergence and therefore nothing could be lost in the translation from what is shown on the illustration to what can be achieved in real life.


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