What makes indexed universal life insurance unique is how the policy cash value is credited.

Index refers to the underlying indices being used to determine how the policy cash value is credited.

The most common and well-known index used in indexed universal life is the S&P 500. Depending on the carrier and product you will likely have access to several indices.

While the performance of the chosen index determines how the policy’s cash value is credited, the policy is not actually “invested” in the index.  Because of this, the amount credited to the policy is contractually guaranteed to be at least zero.

Even if the chosen index performs negatively, the policy crediting rate is guaranteed to never be less than zero.

Insurance companies do this by purchasing options on the chosen index. Because of this, they can eliminate any negative returns in years where the chosen index is less than zero.

To guarantee a return of zero percent (even in years when the index returns -37%), insurance companies had to develop crediting methods. Crediting methods determine how much of the positive returns the cash value of the policy will be credited.

The best analogy is to think of a floor and ceiling. The floor is the guaranteed rate. This is the worst you can do. The return on the index can never be lower than the guaranteed rate or floor.

The ceiling represents the maximum amount the cash value can be credited based on the performance of the chosen indices. This represents the ceiling. The ceiling will be determined by the chosen index and crediting method.

The ability to avoid negative returns is the most important feature of indexed universal life insurance.

Although these policies include a contractual guarantee of zero or higher it is possible for the cash value to go down in any given year. The reason for this is policy fees, administration, and mortality expenses are still taken from the policy to support the death benefit.

Some policies do guarantee a certain cash value over a specified period. When evaluating indexed universal life insurance, it is important to understand how the policy you are evaluating works.