Historical Market Movements and IUL
Run Indexed Universal Life against an 81-year study of the S&P — 62 positive years, 19 negative — and the shape of the trade becomes concrete: the 0% floor would have erased all 19 losing years, the cap would have earned its keep in the nine mid-range years, and an uncapped option with a 5% spread would have beaten the cap in 35 of the 62 positive years. That’s the actual record, year by year, which is far more useful than the averages fund companies advertise — and it’s all walked through below, along with market behavior back to 1900.
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The 81-year study
Positive years and IUL’s caps
Uncapped options and the spread
Blending your allocations
Nobody can tell you what the market will do next. What we do have is a long record of how it has behaved, plus a study of the S&P covering 81 years, and that lets us ask a much more specific question: what would an indexed universal life policy have done through all of it? There are no guarantees in that exercise. It’s critical thinking, and it’s a good deal more useful than an average.
Dow Jones vs. the S&P 500: Using One as a Proxy for the Other
The Dow Jones Industrial Average and the S&P 500 aren’t the same index, but they aren’t that dissimilar either. Compare them over two years, over five years, or over the whole run back to 1985 and they move in tandem — when one is going up, so is the other.
That’s useful, because the Dow’s record reaches back to 1900. Using it as a proxy lets us look at market behavior over a far longer window than the S&P gives us on its own.
How Markets Have Behaved Since 1900
People fairly ask whether it will be different going forward. I don’t know. All I know is what has already happened — and what has already happened since 1900 includes world wars, inflation, hyperinflation, deflation, depressions and recessions. This country has been through all of it.
The shape of it is fairly consistent. Markets consolidate for a while, then trend, then crash, then consolidate again. One stretch of crash-and-trend worked out to be a consolidation in its own right — a major one, and the one most people still remember — and then the market trended again.
Here’s the part worth noticing: at no point does the market simply go down, and down, and keep going down forever. If it ever does, we all have much bigger problems than our paper assets — insurance, stock certificates, deeds to real estate, closely held business interests, any of it.
The 81-Year Study: 62 Positive Years, 19 Negative Years
The study is one a third-party mutual fund company put together, and it starts in 1937. Of those 81 years, 62 were positive and 19 were negative. That’s a long enough period to be worth something on its own.
The fund company presents its results as market averages. I’d rather not use averages. I’d rather take the actual years, one at a time, and ask what indexed universal life would have done in each of those environments.
The obvious place it helps is the negative years. IUL’s contractual 0% floor wipes out all 19 of them and replaces each one with a zero credit, so you sidestep a good deal of the volatility that shows up in the long market record. And because of the annual reset — each year’s index credit locks in and is never given back — a crash the year after a great year doesn’t claw anything out of your account. Your compound curve never has to climb back to where it already was.
That matters most late in a working life. If you’ve worked your whole career to retire and the market takes a deep cut right at that point, you may never come back from it — even if the market itself does. Having to draw income from your portfolio during the recovery, or wait an extra 10, 15 or 20 years to retire, is a real cost.
The same holds for a long consolidation period, the sort many people sat through for a decade. For the pool of assets inside the policy, that gets wiped out too — which is the whole point. You can draw from your indexed universal life while your mutual funds and stocks heal.
The Positive Years and IUL’s Caps
Now the downside, because there is one. IUL caps your upside. A typical one-year S&P strategy pairs a 0% floor with a cap somewhere in the neighborhood of 11%, 12% or maybe even 13%. That’s a good cap. But it does mean giving up the big trending years.
So how much did the cap actually cost across those 62 positive years? Ten of them landed between 0% and 6%. You’d have earned a positive credit, but you could have gotten close to that anyway by sitting in the policy’s fixed account — plenty of IULs offer one paying somewhere between 3% and 4%, with no chance of taking a zero in a down year.
Nine of the positive years came in between 6% and 12%, and that is squarely IUL’s strike zone — better than the fixed account, and double-digit crediting without worrying about market losses at all.
The rest is where the cap bites. Eight of the 62 years returned 12% to 18%, sixteen returned 18% to 24%, and nineteen returned more than 24%. In every one of those you hit your cap and left the excess on the table.
Uncapped Options and How the Spread Works
That’s exactly why I like carriers that offer some sort of uncapped option, and they’ve become more and more common inside indexed universal life. They usually come attached to something called a spread.
A spread behaves like a fee, but it isn’t one. It only applies in years the index is positive — credit a zero and no spread comes off, because there’s nothing to take it from. A common arrangement is a 5% spread in exchange for removing the cap.
Run the 81 years through that. In the negative and flat years you take a zero either way, and the cost of insurance still erodes some cash value. In the nine years that credited 6% to 12%, the spread comes off the top, so you’d have been better off in the traditional one-year S&P cap. Subtract five from those returns and it’s a little worse than a wash — not devastating, but worse.
The eight years above 13% are closer to a coin flip, depending on the exact return. Once you’re past 18%, the uncapped option pulls ahead — 19.5% less the spread is 14.5%, and 22.5% less the spread is 17.5%, both comfortably past any cap in that 11% to 13% range.
Blending Uncapped, Capped, and Fixed Accounts
Add the 16 years and the 19 years together and you get 35 of the 62 positive years where the uncapped option would have beaten the cap. That’s worth having available to you.
And it doesn’t have to be an either-or conversation. Inside an indexed universal life policy you usually get to allocate, so you don’t have to pick this or that. You might put 60% into the uncapped option, 35% into the one-year capped S&P option, and 5% into the fixed account at, say, three and a half percent.
That last slice is small on purpose. In a year where the index gives you nothing, a portion of your cash value still earns a little something instead of flatlining. These are the levers we actually work with when we’re designing a policy around someone’s risk tolerance.
Why Being Tactical With IUL Is Different From Market Timing
People talk negatively about market timing in the context of stock investing, and it’s understandable. Dalbar’s studies on average investor returns show people buying at the top and selling at the bottom, over and over.
With indexed universal life it can be different. You always have that 0% floor, and every option participates in some of the upside movement — which leaves room to be a little more tactical about which option you pick.
After a big rebound you might allocate more toward the uncapped option. In a choppy stretch where you’re genuinely unsure what’s coming, you might throttle the uncapped option down, sit in the one-year S&P, and blend in some fixed account. Coming out of a consolidation that has dragged on for more than a decade, you might decide there’s room to run and throttle back up.
I don’t mind people being a little more tactical with indexed universal life, because you’re not risking missing out on participation. Whichever strategy you choose, you get something in the up years — and in the down years there are no losses waiting to be made up.
History can tell you how the trade behaves; it can’t tell you how to set your allocation. That depends on your caps, your carrier’s uncapped options, and your own risk tolerance — the levers we work with on every design. Click here to schedule a call with us to take a deeper dive into how this could look for your situation going forward.
BankingTruths.com is John “Hutch” Hutchinson’s independent education and brokerage platform, not a captive agency tied to one carrier. Educational only. Indexed Universal Life policies involve fees, caps, participation rates, spreads, policy charges, and loan risk. Index credits are not guaranteed. Policy loans and withdrawals may reduce cash value and death benefit, may cause the policy to lapse, and may create taxable income if not managed properly. This analysis represents the author’s professional opinion based on 19 years of experience and should not be considered tailored financial advice for your personal situation. Consult your tax, legal, and financial professionals before implementing any strategy.