Maximum Premium Indexing Curtis Ray

[krishawkins]

You guys are right. I'm trying to work the math on this as if I'm the insurance company.

Let's say a client has a policy with a 270k value. I park that in treasuries and at the end of the year I will earn 1% on it, or $2700. Knowing that's what I will earn I go out and buy $2700 worth of call options. As it works out, one December 2021 at-the-money call option on the SPY etf is exactly $2700. So I buy one call option.

One year from now, the S&P 500 has gone up 10% and the SPY etf, which was at 370, is now at 407. This means our call option is worth $3700 at expiry.

Seeing that the market is up 10%, the client is expecting to be up 10% on his 270k account, or $27,000. Unfortunately our $3700 gain is not anywhere near that amount.

Even if we parked the 270k in mortgage backed securities yielding 3% we don't make near enough to buy enough call options to hit the target here.

We actually need to park that 270k in something yielding over 7% to earn enough to buy the equivalent number of call options.

Nothing remotely close to risk-free is yielding 7% right now. I don't see how this can work.

What am I missing here guys?

 

[krishawkins]

Thought about this a bit more. They might be able to pull this off by doing bull call spreads on SPY, ie buying the 370 strike calls and simultaneously selling the 400 strike calls.

Then the insurance company would cap the client's return at 8%.

They still need to be yielding over 3.5% to make this work though. Which I suppose might be possible in some mortgage backed securities?!

 

[Tahoe Ray]

What am I missing here guys?

All of the fees charged and the fact that insurance companies look several years down the road.

 

[Allen Trent]

Thought about this a bit more. They might be able to pull this off by doing bull call spreads on SPY, ie buying the 370 strike calls and simultaneously selling the 400 strike calls.

Then the insurance company would cap the client's return at 8%.

They still need to be yielding over 3.5% to make this work though. Which I suppose might be possible in some mortgage backed securities?!

Most insurers overall portfolio yields are 4-5% currently. In part because of previous bonds purchased paying higher rates stock returns on the small quantities of equities they can hold. So, old bond purchases are holding some of this up today, but with sustained low rates, it is not looking good going forward for carrier yields & that will impact all products over time including term, WL both in pricing & dividends & IUL in caps & participation rates & potentially pricing.

Old bond purchases helping current product I believe is why NWM WL looked so good into the late 1990s & 2000s as other carriers crediting was lower. My understanding is NWM went long with 30 yr bonds back in the 1980s when most were holding 10 yr at the longest

 

[pbar]

You guys are right. I'm trying to work the math on this as if I'm the insurance company.

Let's say a client has a policy with a 270k value. I park that in treasuries and at the end of the year I will earn 1% on it, or $2700. Knowing that's what I will earn I go out and buy $2700 worth of call options. As it works out, one December 2021 at-the-money call option on the SPY etf is exactly $2700. So I buy one call option.

One year from now, the S&P 500 has gone up 10% and the SPY etf, which was at 370, is now at 407. This means our call option is worth $3700 at expiry.

Seeing that the market is up 10%, the client is expecting to be up 10% on his 270k account, or $27,000. Unfortunately our $3700 gain is not anywhere near that amount.

Even if we parked the 270k in mortgage backed securities yielding 3% we don't make near enough to buy enough call options to hit the target here.

We actually need to park that 270k in something yielding over 7% to earn enough to buy the equivalent number of call options.

Nothing remotely close to risk-free is yielding 7% right now. I don't see how this can work.

What am I missing here guys?

Nice to see others interested in figuring this out. At one point, I was very interested in these policies. I got burned due to cap rate reduction and badly designed policies. Now, I replicate this way of getting Index returns in my brokerage account and I don't have to worry about cap reduction either. If interested in comparing notes, I can send you a private message.

I know the conventional narrative by the insurance agents is that the insurance companies invest in bonds and then buy call options but I suspect something else. Nobody knows for sure and it's all speculation by the agents. What if the insurance companies invest all the cash value in the etf SPY? Risky you say? But what if they buy ATM Put options so that they exercise their put options if the S&P is down for that year? Expensive you say? But they can pass on the cost of the put options as expense to the policy owner. They can also offset this expense by selling OTM call options and dividends paid by S&P index. If S&P returns 20 or 25%, they can credit whatever was the cap rate to the policy holder and keep the rest as their profit. Others can disagree but this is perfectly possible. Anyway, I started doing this in my brokerage account and am much happier. I can say I don't need any Indexed universal policies if I think of the cost of put option as the policy expenses. Yes, there is no death benefit but that is solved by cheap term policies.

 

[krishawkins]

He's honest...

 

[krishawkins]

I know the conventional narrative by the insurance agents is that the insurance companies invest in bonds and then buy call options but I suspect something else. Nobody knows for sure and it's all speculation by the agents. What if the insurance companies invest all the cash value in the etf SPY? Risky you say? But what if they buy ATM Put options so that they exercise their put options if the S&P is down for that year? Expensive you say? But they can pass on the cost of the put options as expense to the policy owner. They can also offset this expense by selling OTM call options and dividends paid by S&P index. If S&P returns 20 or 25%, they can credit whatever was the cap rate to the policy holder and keep the rest as their profit. Others can disagree but this is perfectly possible. Anyway, I started doing this in my brokerage account and am much happier. I can say I don't need any Indexed universal policies if I think of the cost of put option as the policy expenses. Yes, there is no death benefit but that is solved by cheap term policies.

The puts look too expensive to me to pull this off. Right now buying puts would cost 8-10% of the portfolio... At what level are you selling calls to offset this cost? You would cap yourself pretty low I think...

 

[Allen Trent]

The puts look too expensive to me to pull this off. Right now buying puts would cost 8-10% of the portfolio... At what level are you selling calls to offset this cost? You would cap yourself pretty low I think...

that was my thinking also & that flat years could hurt because of those costs. I would love to find an efficient way to do some of this with a portion my own equities portfolio as I tend to be more conservative than many. love to protect some of the downside & ok giving up some of the upside.

Thinking of researching some of the RILA products out there to compare

 

[pbar]

The puts look too expensive to me to pull this off. Right now buying puts would cost 8-10% of the portfolio... At what level are you selling calls to offset this cost? You would cap yourself pretty low I think...

This is definitely not a buy and hold strategy for me anymore. You need trading skills and timing the market with technical analysis helps. Initially, I used to put this on for 1 year like in IULs but have evolved from that. I will reply to your private message. This is all too proprietary to post on a public forum.

To stay on the IUL discussion, don't the insurance companies charge a premium load of 5% to 10% every year? They could be buying puts with this load. They have other expenses too like administrative expenses, other expenses, cost of insurance. They could be using policy holders money to earn returns and keeping some for themselves. We know Warren Buffet used his insurance company to collect premiums and invest in the market. That's how he became rich. For all we know, Insurance companies could be using the IULs to do the same thing and this time with protection with put options.

 

[hunschuld]

Interesting to see the twists something simple has taken.

The concept can work if you are conservative and build up capital before the loaning begins but is not for the faint of heart. it is based on the spread between the loan rate and the potential crediting rate and the fact that loans do not come out of policy cash value. They come from company assets and the cash value is the collateral for the loan.

Assume $10,000 annual premium and max funded policy. If after year 2 you have over $10,000 in loan value. Assume a max loan rate of 6%. You take $10,000 loan and then make a $10,000 premium payment.
assume you get 10% for the S&p index credit for the year. Your $10,000 premium earns 10% and your $10,000 loan earns another 4%. The 10% credit - the 6% interest paid. In essence you now are earning 14% as your policy interest instead of 10%. This concept has been around for years and seems to be working however I would not be surprised if the aggressive versions of this are starting to have problems. Done on a conservative basis the math works, meaning at least 5 years of premium payments before the loaning begins and the agent must have the ability to mange the policy. This is not a sell and forget.. There are ways to make the concept even safer.
It is a modern twist on the 4 out of seven rule.