2 Common Index Crediting Methods Used by Indexed Universal Life (IUL) Insurers

Insurers determine the rate of return to enter into their interest crediting formulas in their Indexed Universal Life (IUL) policies using a variety of crediting strategies. The most common are the point-to-point (or “ratchet”) method—calculated either annually or monthly—and the monthly averaging method.

1. Point-to-point crediting methods. Both of the point-to-point crediting strategies begin the crediting cycle with a marker at the beginning of the contract, and track the movement of the underlying stock index(es) to the next point. For annual point-to-point, the insurer tracks the index for one year; for monthly point-to-point, one month. The difference from the first point to the second point represents the percent of interest that enters the policy’s interest crediting formula.
2. Monthly averaging method. Under monthly averaging, insurers track monthly index changes and then average them over twelve months. This annualized average rate then enters the annual interest crediting rate formula to determine the amounts insurers will credit to cash values at the end of the year.

Example. Using the annual strategy, if the index rose 5 percent over the course of a year, 5 percent would serve as a starting point in the interest crediting formula determining the amount the insurer will credit to policy cash values. Under the monthly strategy, if the index rose 1 percent in a month, the interest crediting formula would use 1 percent in the calculation of the amount of interest to add to cash values.

Problems with averaging strategies. The problem with the interest crediting strategies is that they are usually hard for policyowners to understand. Additionally, one never knows in advance which crediting strategy will produce the best outcome for a policyowner over the course of the next twelve months. Also, many policies make the policyowners commit to a crediting strategy for relatively long-term periods, such as five-year segments. This means that if a particular crediting strategy does not perform as the policyowners had hoped, the policyowners cannot move the money that they already have allocated to that crediting strategy until the end of the five-year segment.

`Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM`