Indexed universal life insurance is a type of permanent life insurance with a subaccount that can accrue cash value; the earnings rate is attached to a financial index such as a stock index. A stock index is a way to track the performance of the stock market by computing the prices of selected stocks.
It also allows investors and financial professionals to compare the value of specific investments. The Standard and Poor’s 500 is a commonly used stock index; it is the value of 500 stocks that is tracked every day on the financial markets.
This type of policy offers the advantages of earning interest on your investment without the drawbacks of losses tied to the whims of the stock market.
These policies are designed to offer more stability, so the premiums aren’t directly invested in the stock market like variable universal life insurance premiums. Instead, the financial value of the index is used to calculate how much interest is credited to your indexed universal life insurance policy’s cash account.
The insurance company will cap or limit the maximum amount that can be credited to your account and also buffer your downside with a guaranteed interest rate if the stocks decline in value. The insurance company’s ability to credit your account depends on how well the carrier’s investment portfolio (commonly bonds) performs.
In other words, when the stock market does well, your investment in the policy grows accordingly up to the cap. You may choose a guaranteed interest rate in the event the company’s portfolio does poorly, or accept a zero percent growth in your cash account during that time.
With an indexed universal life insurance policy, the crediting rate for your cash value is determined by a formula, instead of being at the insurance company’s discretion.
The specific formula is outlined in the policy documents, but is usually related to the performance of the stock market. You should always examine this formula carefully to understand your projected rate of return.