What do Caps, Floors, and Participation Rates mean in an IUL
It is important to have a good understanding of the various components that are used in determining the return on a LIRP – and in particular, caps, floors, and participation rates – as these can have a significant impact on your LIRPs overall return.
What is an IUL Cap?
The cap is the maximum rate of interest that may be credited to the policy in a given contract year. As an example, if the cap rate is 6%, and the underlying index returns 8% for a contract year, then the cash account will be credited with 6%.
Keep in mind, though, that if the underlying index has a negative return for a given contract year, the account will not lose value – even if the index suffers a double-digit loss for that time period.
What is the IUL Floor?
The floor is the minimum guaranteed return for the interest that is credited to the policy’s cash value component. Many IUL (index universal life) policies will have a 0% floor, which can ensure that the policy won’t lose value, even if the underlying index performs poorly.
There are some IUL policies that offer a floor of 1% or 2%, which means that the policy is guaranteed to receive at least some amount of positive interest credited to it, no matter how the index performs. In any case, your principal is protected.
How Do IUL Participation Rates Work?
An index universal life insurance policy in a LIRP may also use a participation rate in calculating the return. This rate determines how much of the underlying index’s increase will be used in computing the return in the cash value component.
For instance, if the participation rate in the policy is 80%, then the cash value component will be credited with 80% of the underlying index’s return. In this case, if the index has a 10% return in a given contract year, and the policy’s participation rate is 80%, then there would be an 8% return credited to the cash value.
80% X 10% = 8%
It is important to note that some IUL policies will have both caps and participation rates. With all of the moving parts that can be found on a LIRP, it is recommended that you first discuss your objectives and your options with an advisor who specializes in these plans before you make a long-term financial commitment.