Cap rate

The cap is the other side of the floor in an indexed universal life (IUL) policy. The policyholder gives up index gains above the cap in exchange for a 0% floor in falling years. Capped returns, a cap on earnings, a cap interest rate and a growth cap all describe the same limit.

How it works

At the end of a 12-month segment the insurer measures the index change on price return, multiplies it by the participation rate and limits the result to the cap. The floor then applies to a negative result. The cap that counts is the one set when the segment starts, and it holds for the full twelve months.

Insurers typically fund index credits by spending part of their general account's investment earnings on index options. When that budget or the price of options changes, the insurer can change the cap for new segments, down to the minimum in the contract, such as 3% on some contracts. Each index account has its own cap. Some accounts have no cap and limit the credit through a participation rate or a spread instead, and where a product offers a multiplier, the credit can exceed the headline cap.

Worked example

Illustrative figures, not a forecast. A segment of US$100,000 with 100% participation and a 0% floor, under a 9% cap and an 11% cap.

• Index +15%: credit 9% (US$9,000) or 11% (US$11,000).
• Index +10%: credit 9% (US$9,000) or 10% (US$10,000).
• Index +6%: credit 6% (US$6,000) under either cap.
• Index −8%: credit 0% under either cap.

With 80% participation and a 9% cap, a 10% index rise counts as 8%, below the cap, so the credit is 8%.

In an international IUL

International IUL contracts typically set caps between 9% and 11% a year on annual point-to-point accounts. Because credits use price return, the cap is measured against the index's price change, with dividends excluded. Caps vary by insurer, product generation and index account, so an S&P 500 account and a Shariah index account on the same policy can carry different caps. Today's cap may be lower in year 20, which is why illustrations are also read on a stress-test basis 1% a year below the main assumption.

Common questions

What is a good cap rate for IUL?

On international IUL, caps are typically between 9% and 11% a year. The cap is best compared together with the participation rate, the policy charges and the minimum cap in the contract, since all four shape the result.

Can the insurer lower the cap?

Yes, for new segments, down to the minimum set in the contract. A segment that has already started keeps its cap for its twelve months.

Why does IUL have a cap?

The cap keeps index credits affordable while the 0% floor stays in place. The insurer funds index credits from a set budget for each segment, typically by buying index options, and the cap keeps the cost of those options within that budget while the 0% floor stays in place.

Go deeper: how IUL works, with the full crediting figures.