Participating loan (indexed loan)

A participating loan is the second type of policy loan on an indexed universal life (IUL) policy, alongside the fixed loan. Each year the result on the borrowed money is the index credit less the loan interest, so it can be positive or negative.

How it works

The insurer lends against the cash value, and the full cash value, including the part backing the loan, stays in the index segments the policyholder has chosen. Each year:

1. the insurer charges interest on the loan balance at the participating loan rate;
2. the cash value backing the loan is credited at segment maturity under the cap rate, participation rate and floor, like the rest of the policy;
3. the net result on the loan is the index credit less the loan interest.

When the index credit beats the loan rate, the policy gains on the borrowed money. When the credit is lower, including a 0% year under the floor, the full loan interest is still charged and the policy bears the difference. On some contracts the participating loan rate is fixed in the policy. On others it is a variable loan rate, which the insurer resets from time to time under the policy terms, so the cost can move as well as the credit.

Worked example

Illustrative figures, not a forecast. A participating loan of US$100,000 at 6% a year. Settings: 9% cap, 100% participation, 0% floor. The comparison is a fixed loan charged at 6% and credited at 4.75%, a net cost of US$1,250 a year.

• Index +11%: credit 9%, or US$9,000, less US$6,000 interest. Net gain US$3,000.
• Index +6%: credit US$6,000, less US$6,000 interest. Net nil.
• Index +4%: credit US$4,000, less US$6,000 interest. Net cost US$2,000.
• Index −5%: credit 0% under the floor, less US$6,000 interest. Net cost US$6,000.
• Three 0% years in a row, interest paid each year: net cost US$18,000, against US$3,750 on the fixed loan.

The risk sits in runs of flat or falling years, especially when loans fund income and the interest is added to the loan, because the balance compounds while the borrowed money earns nothing. This is sequence-of-returns risk applied to the loan.

In an international IUL

On international IUL, caps are typically 9% to 11% on annual point-to-point segments, and participating loan rates are quoted gross, for example 6% a year. With the cap a few points above the loan rate, the gain in a good year is limited to that gap, while a 0% year costs the full loan rate. Paying the interest each year from outside the policy keeps the balance at the amount borrowed, and the policy gains in every year when the credit beats the loan rate. Where the contract offers both loan types, the offshore trust or company that holds the policy chooses, and annual reviews track the loan against the cash surrender value.

Common questions

Is a participating loan the same as an indexed loan?

Yes. Participating loan and indexed loan describe the same design: the loaned amount keeps earning index credits while loan interest is charged. A variable loan rate is a separate feature: the interest rate itself can change.

What is variable loan interest in IUL?

A loan interest rate that the insurer resets from time to time under the policy terms, in place of a rate fixed for the life of the loan. With a participating loan on a variable rate, both sides of the calculation move: the index credit and the loan cost.

Can a participating loan cost more than a fixed loan?

Yes. With both charged at 6% and the fixed loan credited at 4.75%, the participating loan costs more in any year when the index credit is below 4.75%, and less in any year when it is above.

Go deeper: model a participating loan in the calculator and loan or withdrawal compared.