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Fleming Financial Services Blog

At Fleming Financial Services, Inc., our role is to assist our clients in defining and realizing their financial objectives and goals. We work with our clients to implement personalized plans designed for their unique situations. Our areas of concentration are: Retirement planning, Estate and Wealth Transfer strategies, and Business Continuation planning. We emphasize the importance of conducting our business with integrity and professionalism. As a member of PartnersFinancial, an independent national financial services company, we are able to provide access to sophisticated resources for the benefit of our clients. Some of the professionals with our firm are currently registered to conduct business through NFP Securities, Inc. With those additional resources in place, we help facilitate the complex corporate and personal financial decisions our clients must make.

INDEXED UNIVERSAL LIFE: Mechanics and Capabilities - Part 4

Thomas Joseph Thomas Joseph , 10/23/2014
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Celeste Moya, AVP, Product Management, NFP Life FinanceRelationship to Options Pricing Indexed UL products have a unique structure, because the interest credited is tied to the performance of an index; however, premiums are not invested directly in the stock or bond market, nor do insurance companies actually purchase stocks of companies in the index to cover the costs of crediting index returns. Insurance companies choose to hedge the index crediting risk by purchasing options from a third-party financial entity, such as an investment bank, that provides a guarantee to pay the index return in exchange for a hedge cost for the liability associated with the IUL crediting. This allows the insurance carrier to pass indexed gains along to the client without assuming the risk of a stock or bond investment. The hedge package or options an insurance company purchases are specifically designed to match the cap rate, participation rate and floor associated with an index account. The return from the options is paid to the insurance company by the options seller (i.e., investment bank), and the insurance company then provides an index credit to the IUL policy based on these returns. By hedging the index account in a manner that replicates the participation limits and pushing market risk to a third-party financial entity, the insurance company is largely profit-neutral, as it does not lose more money if returns are below the floor, but it also does not make more profit if returns are above the cap. The insurance company’s options budget is derived from their general account yields; therefore, the most significant risk the insurance company assumes is not being able to earn enough from the general account to allow for their options budget. This makes the price to purchase options a key element of the IUL model, as the options’ cost effectively determines the participation limits within the policy and the long-term performance of the product. The insurance company will adjust participation limits based on the cost of options. If options prices rise, the carrier will have to lower the cap rate, adjust the participation rate or cover their contractual obligations from their own reserves and surplus.  In most cases, this situation would result in a lowering of the cap or participation rate, resulting in decreased upside potential for the IUL policy and ultimately hindering long-term cash accumulation. This could also result in a policy lapse or additional premiums to keep the policy in force.   Copyright © 2013 NFP. All rights reserved.