Additionally, I have been interacting with an attorney who has taken the position (extreme position in my opinion) that the advisor who does not recommend EIUL products will be subjecting themselves to potential liability down the road. While I suspected his comments were tainted (I found out that he has affiliate programs with insurance carriers and thereby financially benefits from the relationship), I decided to complete my own research into this product.

I have been scouring the internet for several weeks looking at the pros and cons of universal life insurance and specifically EIUL. I have also discussed the topic with other advisors in the following industries:

1) Insurance
2) Financial
3) Legal and
4) Accounting

As you might suspect, I have either received either glowing comments from category 1 above, scathing comments from category 2 and most surprisingly, not much help from categories 3 and 4 when trying to get technical data on how the guarantee claims are base and how exactly the underlying investments are constructed.

Michael (Michael@theinsuranceinsider) above gave what I thought were very useful hint at how the underlying investments in the EIUL product worked and did much to confirm some of my initial concerns with the EIUL product, especially when he discussed the origins of the development and how the original assumptions were made. Essentially, I knew that investment structure was probably similar to products produced by the large wire houses such as Goldman Sachs in the 1980′s.

What was created was either a mutual fund or unit trust that claimed that the investor could have the best of both worlds; no loss of principal while sharing in market gains. The investments all had similar basic designs; they essentially took a series of discounted fixed income investments such as treasury bills and set them up in such a way that once the discounted bonds came due, the fully matured value was equal to roughly the original investment. The remaining portion of the investment was then set up in a series of what Michael above called “hedges”.

What I believe what he was referring to more specifically were option hedges (these were the primary investment vehicles used by the brokerage industry). For example, one type of hedge could be selling a covered call on an underlying investment or index. However, another strategy could simply be buying (going long) option calls and/or puts. Without getting into whether these strategies made any sense, they were ways that the money manager could take advantage of market returns while capping market risk. This also allowed for a large degree of leverage as options positions had lower carrying costs then holding the actual securities.

The suspicions I had about the EIUL guarantees is this: During periods of generally rising markets, the above mentioned strategy has a large probability to produce some kind of small yet positive gains. While poor months definitely have an impact on your overall gain capture (I thought Kyle made a great observation here as this was something I had –embarrassingly- not considered), my primary concern was what would happen if we were to experience a long period of market decline.

And this is what I have concluded (and decided to share in this forum). It is my opinion (for whatever it’s worth) that we are currently in an economic decline that will affect the traditional capital markets (stocks, bonds and real estate). If I am correct, than the underlying investment structure supporting the EIUL product is not simply flawed; it is seriously flawed.

In declining markets, hedges such as covered calls will expire worthless. Buying calls with options will end with the same result. I also agree with Michael’s assessment that the cost of putting on these hedges will go up. Keep in mind that unlike simply holding the underlying stock, the simple act of increasing volatility results in higher hedging costs. Finally, I would be very curious to know if the insurance companies are really “hedging” for the worst case scenario by offsetting the portfolio with discounted t-bills.

While put buying would present possible gains, that further assumes that whoever is managing these assets will be as astute as the rest of us professionals in the industry (that includes money managers as myself, mutual funds or any other prognosticator out there) to know when to essentially sell the market short. From my own experience, that person or company is a truly rare breed.

I would love to hear any feedback from anyone on this blog, whether from in or outside the insurance industry. All I ever intended to do was to try to understand how the EIUL works, and not whether is was a “better” or “worse” investment than anything else. What I found is that there is a serious learning curve here and that the industry that created has been around for a long time. This same industry also possesses (like the securities industry) a very strong lobby.

I do not believe (unless someone can convince me otherwise) that there is enough full disclosure to investors about the risks associated with EIUL. It is also easy for me to understand how it is very likely that most sellers of this product don’t really understand it (I am not certain I still have managed to get my arms fully wrapped around the concept), but whenever any industry starts using words like “guarantee” or “…no loss of principal”, I begin to wonder how solid the guarantor is.

I have no problem with companies wanting to make money. And while there has been much said about abusive sales practices in the insurance industry, I can tell you all from personal experience that they pale compared to what the securities industry (both from broker-dealers as well as government bureaucrats) has subjected the everyday investor to over the past 80 years.

If I am right (and hell, that hasn’t always occurred) then the EIUL contracts will potentially face many lapsing issues that were experienced by many insurance contracts in the 1990s and beyond. I personally acted as an arbitrator in one insurance related case where the contract basically blew up because it was bought during a period of higher interest rates and therefore the illustrations were very optimistic. I see no difference in the EIUL that bases its claims of guarantee on the bet that the stock market will tend to yield positive returns in the long run.

If the insurance industry ends up being wrong (as they have in the past) it’s going to be a busy time for litigators and arbitrators. In the end, it will be the investors that take the loss.

To that I would respond: Nihil Nova Sub Luna.

Do you still own the EIUL policy and how has that been working out for you? I would love to hear periodic reviews (and I’m sure others as well) as I’m thinking about getting an EIUL policy myself. Thanks for your time

You discovered one of the amazing “small-print” pitfalls on these products: your losses are capped at zero for the year, but only your gains are capped from month to month. So very good months don’t do anything for you, but very bad months eat up all your gains. Your chart is worth ten thousand words.

What I don’t think you’ve talked about is the “moving parts” that are in every–and I mean every–indexed life product I’ve looked at closely. You say your annual returns are capped at, say sixteen percent? But it turns out the insurer can lower that cap to as low as one percent, and you don’t get any say in the matter. Whoops! It’s not a “guaraneee” if they don’t actually have to pay it. Similar “moving parts” can be found all over these policies–especially in fees. (“But Minnesota Life (or whoever) has never used those clauses,” say the snake-oil salesmen. “Fine,” I say. “Then let’s take them out of the contract.” Silence.)

Bottom line, these are terrible, terrible products–deliberately confusing, with lots of little sharp edges that will cut you to ribbons. When even an insurance salesman is admitting the complexity of these products in the comments, you know something’s not right.

I personally own 5 of these and what i would recomend you do before you throw the baby out with the bath water is do some research and reading then make up your own mind. In the end the only question you should have should be.. do I use a dividend paying whole life or an inexd ul to build wealth safely. Personally I never met a person that said other options are better than a life policy that had ever run a spread sheet to compare them, it they had they would own it themselves. i’ve run out of time but if your interested I’d be glad to give you a list of books to read that should open your eyes.