Indexed Universal Life (IUL) policies are often marketed as offering the best of both worlds: the upside of market-linked returns without the risk of direct market losses. But behind the glossy sales illustrations, a growing number of policyholders are discovering that their cash value growth falls far short of expectations. A key culprit? Engineered indexes.
What Are Engineered Indexes?
Unlike traditional benchmarks, like the S&P 500, engineered indexes are proprietary formulas created by banks and insurers. They combine multiple asset classes—stocks, bonds, commodities, volatility measures—into a custom “index” that is supposed to deliver more stable returns. They’re often marketed as being designed for IULs, complete with attractive back-tested performance.
Why They Appeal to Insurers
Insurers love engineered indexes because they give them control. The index is usually coupled with options strategies that are cheaper to hedge than traditional benchmarks. That means the insurer can offer attractive illustrated caps or participation rates at relatively low cost to themselves.
The Problem: Why They Underperform
Despite slick back-tests, these indexes frequently lag real-world expectations. There are several reasons for this:
1. Back-Test Bias – Engineered indexes are built using historical data that makes them look good in hindsight. The “curve fitting” rarely holds up once live results come in.
2. Low Volatility = Low Growth – Many engineered indexes are designed with volatility controls to make hedging cheaper for insurers. But volatility is what drives higher option values. The lower the volatility, the lower the real-world credited interest.
3. Moving Goalposts – Participation rates, caps, and spreads are not fixed. Insurers can and do adjust them downward over time, further dampening long-term results.
4. Hedging Costs Rising – Even if the index performs, the cost to hedge may increase, and insurers often reduce crediting rates or participation percentages to protect their own margins.
The Result for Policyholders
Instead of the “market-like” returns they were promised, policyholders often end up with growth barely above the minimum guaranteed rate—sometimes not even enough to sustain the policy long-term if charges are high. This can lead to diminished cash value, the need for higher premium contributions, or even policy lapse.
What Policyholders Should Know
• Don’t Rely on Illustrations Alone – Those glossy charts often assume caps and participation rates will remain stable, which is rarely the case.
• Ask About Real Historical Returns – Not back-tests, but actual performance since the index launched.
• Understand Insurer Discretion – Even if the index performs, your credited interest depends on the insurer’s ongoing decisions about caps, participation, and spreads.
Bottom Line
Engineered indexes may look sophisticated, but their design often tilts the playing field toward insurers, not policyholders. If you already own an IUL with one of these indexes and find your policy underperforming, you’re not alone—and you may have legal options.
