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What is an IUL

What is an IUL?

In this article we will be going over various types of life insurance including the variations of an Indexed Universal Life Insurance Policy. 

Different Types of Life Insurance

There are different types of life insurance policies available, ranging from term life insurance, which is pure death insurance, to traditional dividend paying whole life insurance, which provides cash value growth in the policy.

Universal Life

Somewhere between term life and whole life is Universal Life Insurance. Universal life is cash value life insurance which provides similar benefits of both term policies and whole life policies, depending on the type of universal life policy you choose.


An indexed universal life insurance policy, aka IUL insurance, or simply “IUL”, is similar to traditional universal life (UL) in that it offers a death benefit and a cash value account that increases over time.

And with a universal life insurance policy, the funds in the IUL cash value account grows over time and can be accessed in the form of partial withdrawals or policy loans. It can also be used to purchase more death benefits.

Where IUL differs from UL is that these policies enable policyholders to invest some or all of their available cash account in a sub account option based on the performance of market indices such as the S&P 500 or the NASDAQ 100.

The ability to invest in equity-linked sub accounts with your IUL cash account offers you the chance to experience faster growth during periods when the stock market performs well, subject to policy features such as cap and participation rates.

These features limit how much such sub accounts can grow relative to the performance of the linked index.


And IUL should be differentiated from Guaranteed Universal Life, where the focus of GUL insurance is on the death benefit. In contrast, most IUL policies are primarily focused on high cash value accumulation and growth.


Variable Universal Life (VUL) is similar to IUL insurance but has some distinct differences. When comparing VUL vs IUL, it is important to understand that a VUL is different to an IUL in that, VUL insurance actually participates in the market returns via sub accounts that act like mutual funds that the owner of the VUL can invest in.

Since it invests directly into the market, a variable life policy has unlimited upside and downside, placing it into a higher risk vs reward category than IUL insurance.

Floor, Participation and Cap Rates

An attractive feature of Indexed Universal Life policies is a floor rate, which represents the minimum an index-linked subaccount can earn (or the maximum it can lose) in any one period.

Floor Rate:

The floor rate sets a limit on how much a sub account can lose, or the minimum it can gain, in any one year.

This floor rate is typically set at no less than 0%, which means that even if the index being tracked by your sub account loses money in any one year, your account will not suffer a performance loss, (although some fees or costs may result in a small loss).

In some cases, the floor rate is positive so that whatever the market does, your sub account will earn at least 1 or 2% interest or whatever rate the floor is set at for that year.

While floor rates limit the risk of investing some portion of your cash account in an index-linked sub account within an IUL, the potential to experience gains along with the stock market is the main draw of these types of policies for many.

However, when selecting an IUL policy, it’s important to pay attention to its cap rate and participation rate, as these will determine how much upside you can earn when the market rises.

Cap Rate:

The cap rate is the maximum percentage growth a sub account can experience in any one crediting period. The cap rate varies from one company to the next but is often in the range of 7-11%.

If your policy has a cap rate of 11% and the market rises 20%, the most you can receive for that crediting period would be 11%.

A cap rate usually is locked for one year and can be changed at the insurer’s discretion after the lock has expired.

Participation Rate:

The participation rate determines what percentage of the growth realized by the index the subaccount tracks will be credited to your account, subject to the cap rate.

For instance, if the participation rate is set at 85%, and the index returns 20% for the year, the amount your account would be entitled to receive, subject to the cap rate, would be 17% (85% of 20%).

Further, if the cap rate was 12%, you would receive 12% rather than 14%. If the index returned 10%, you would receive 8.5% (85% of 10%).

As with a cap rate, a participation rate is typically locked for a year, and can be changed by the insurer after the year has elapsed.

Indexed Universal Life Insurance Mechanics

When considering any specific Indexed Universal Life policy, it is important to understand the mechanics of how these policies work.

IUL policyholders can generally choose to allocate the funds within their policy’s cash account between a fixed account and one or more index-linked subaccounts.

Index Period

Allocation to these sub accounts are generally credited with an amount of interest based on the growth of the relevant index over a certain period of time, often called the index period, using two methods used to determine the crediting rate:

Annual point-to-point:

This involves a computation of the growth (if any) in the sub account after taking into account the floor, cap, and participation rates after which this amount is credited to the account.

For instance, if your sub account was linked to the performance of the S&P 500, and it rose 14% for the year, and the account had a 100% participation rate and a 10% cap rate, your crediting rate would be 10% at the end of the year.

In most indexed universal life insurance policies, the new cash value of this sub account then becomes the baseline for the next year when calculating the amount that will be credited to your account.

Monthly average:

A monthly average of the performance of the subaccount is calculated and credited to the account at the end of each month, after taking into account the floor, cap, and participation rates.

To be able to provide the higher credited rates of return that can be generated by equity index-linked subaccounts, insurance companies purchase options on these indices rather than invest in them directly.

The usage of cap and participation rates means that they don’t have to directly match the return of these indices, they simply need to generate enough money to pay the relevant amount of interest representing whatever fraction of the indices’ return the policy owes at the end of the year.

The insurance company will typically invest the funds not used to buy options in bonds to generate sufficient income to meet the policy floor guaranteed return.

Dividend Interest

It should be noted that index-linked sub accounts do not pay dividend interest associated with the indices they track. For an index like the S&P 500, this is typically a not insignificant portion of the index’s total yearly return.

A yearly dividend amount of around 2.5% or even more is common for the S&P 500, which represents a sizable portion of the 9% or 10% yearly total return the index has generated over long periods of time.

Due to the mechanics used to generate earnings to pay interest to index-linked subaccounts, the profit an insurer makes on IUL policies is subject to the premiums charged for buying options on the indices being tracked.

In periods where volatility increases, insurance companies often must pay more to buy options on indices. This extra expense can cause them to adjust the cap and participation rates to reduce the amount of interest they pay on index-linked subaccounts to maintain their profit margins.