Why Doesn’t the IUL Accumulate with Dividend

This is probably another reason why the Index Universal Life (IUL) product is a lousy choice of investment comparatively.

The index account of the IUL product accumulate base on the up and down of an index (for example, the S&P500). The return is floored at 0 and capped at an amount of about 11% (varies depending on the company). However, it does not return the dividend of the S&P500. (What!?)

Say, if you invest directly in the S&P 500, for instance, the index fund ‘SPY’, you would be subject to a return of the index PLUS a return of dividend at about 2% of your investment. That means, if the S&P return 6% this year, you get 6% index return PLUS an annual dividend of 2%.

However, one don’t get such a deal in the index account of an IUL. After purchasing the IUL, your money accumulates at 6% of the S&P return, WITHOUT the 2% dividend.

And why is that?

This is because, when the insurance company sell the policyholder an IUL, it enters into another contract with the financial market to hedge the downside risk of the IUL product. This contract is a call spread (of which, I will explain in another blog post some times later). The using of the call spread allow the buyer to floor and cap a range of gains on the index movement, but not including the dividend.

The dividend, however, will play a part in the cost of the call spread. Say, if S&P500 on average is returning more dividend to the market, the call spread contract will be cheaper for the insurance company to purchase. This in turn translates into cheaper cost to hedge on behalf of the policyholders, and ‘hopefully’ cheaper IUL for the policyholders (which is unlikely, as the insurance companies are already cutting-throat in their competition and other complicated regulation rule are in place to force them to charge a higher cost to maintain the ‘solvency’. ).

So, that’s why the dividend is not included in the accumulation of the index account. Would you like to see that as a future change in the policies offered by the insurance companies? Feel free to leave a comment below.

G.

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