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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76112  
Subject: Re: Retirement, college, and Obamanomics Date: 1/1/2013 9:28 PM
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I'm juggling a toddler, so can't run historical actuals... but if anyone asks, I can, and the IULs (at a 0/15 cap spread) handily beat the single-index S&P in the vast majority of rolling average periods from 10, 15, 20, 25, and 20 years, back since S&P inception.

You do a little happy-dance, but it's rather muted because you didn't get that other 11%. Hmmm, I wonder where it went? The market returned 26%, I got 15%, but where did that other 11% go to? Maybe it went to offset the losses when the floor got hit?
I'll explain (again.)

The hedge trade requires buying a long call at or near the money, which costs more than the fixed yield leg provides in call buying budget.

In order to get back under budget, the actuaries find the furthest forward call strike that they can sell for a credit to get them exactly at their call buying budget (which is their fixed leg yield.)

The person who gains from the market rising higher than the IUL cap is the counterparty that the IUL company sold the short call option to at the high end. That party purchase the right to participate in the market from that strike upwards.


S.W.A.G. = 33% of the time the excess gain was 11% and 28% of the time the avoided loss was 14%, so using handwaving fuzzy math that's pretty close to a wash.
Not even in the same universe as a wash. The IUL trounces the unhedged trades in the heavy majority of rolling periods.

The reason the "handwaving guesses" fail is because a 25% loss requires a 33% gain to simply "break even." Looking at just a column of annual returns and assuming that 'half up, half down, is about equal' is exactly bleeding in losses.

QUICK EXAMPLE;
Start with $100,
Year #1, lose 50%
Year #2, gain 50%
Year #3, lose 50%
Year #4, gain 50%

Look at the columns, and hand-wavers assume a wash.
The math hurts in the real world of money though.


SOMEBODY took the loss when the market lost, and if it wasn't you then it was the IUL company. Likewise, SOMEBODY got the excess gain, and if it wasn't you then it was the IUL company.
Nope, and nope. The IUL actuaries perfectly hedge the trade... they only make their money from their fees, that's it.

'course, the total return of the S&P500 is not just the price. It also throws off dividends, about 2.6% a year average. The dividends come like clockwork, irregardless of any loss or gain in the share price. We don't get any of that, since [almost] all IUL's exclude dividends in the returns credited to you. The market paid a dividend and SOMEBODY received it, and if it wasn't you then it was the IUL company.
Nope, the dividends are baked into the option pricing. When dividends are strong, they reflect in more attractive option performance per cost, allowing the IUL company to buy a spread with higher caps. Nobody is surrendering the dividends of the securities of the underlying positions.

Cheers,
Dave
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