Indexed Universal Life Insurance (IUL) Cap Rate refers to the maximum annual earnings potential when deploying your cash value into any index crediting strategy.
It’s worth noting that some of the top IUL carriers of 2020 with the best performing IUL policies also offer uncapped strategies, still with a 0% floor rate and some sort of hurdle rate that comes off the top of your earnings.
Insurance Companies offering indexed universal life almost always offer some sort of guaranteed annual floor rate of 0% (some have a floor of 1%) along with a top-end cap on index crediting, often in the low double-digit range. Therefore, if the underlying market index being tracked has a negative year, your cash value simply earns 0% growth and the costs of insurance would still be applied.
On the other hand, if the underlying market index has say, a 25% year, your index crediting would be limited to whatever your IUL cap rate is – say 10% even though the underlying market index earned 25%.
Many people believe that this cap and floor rate methodology was created by Indexed Universal Life carriers so they can keep the excess profits. In actuality, IUL caps are the way they are because of the underlying hedging strategies using options to create them. You can learn more about how the insurance companies offering indexed universal life are able to provide these sorts of index crediting strategies here in our indexed universal life pros and cons article.