Stochastic Modeling Could Help Planners Help Clients
The use of life insurance, particularly variable universal life, as a vehicle to generate attractive after-tax retirement income is well known and popular.
To achieve the desired objectives, the policyowner must accumulate premiums–and the higher the premium level the better, as long as this occurs in a non-modified endowment contract (non-MEC.) Then, at retirement, the owner can start taking cash flows from the contract.
Current approaches to illustrate the technique typically use level gross yield assumptions of, say, 0%, 6%, and 10%. The approach is, concentrate on the 10% yield performance, and solve for the distribution that can be paid out over the desired income period.
Unfortunately, this strategy tells very little, since as readers of this publication know, the likelihood of such a scenario occurring is as great as being bitten by a great white shark and winning Power Ball at the same time.
The time has come to investigate new techniques for helping producers and clients plan retirement programs better, so that the desired outcomes are more likely to be achieved. Stochastic analysis may show the way.
Stochastic analysis is a technique that recognizes the uncertainties underlying investment performance, especially those influenced by the vagaries of consumer demand, shifting consumer tastes, the strength of various national economies, inflation, etc.
Thus, even when an average value is assumed and that outcome has the highest probability, a spectrum of outcomes is possible. For example, while the records of the past 50 years may show that an investment in a certain combination of funds may yield an average of 10% over time, and while there may be reason to believe that such an outcome is likely, random events will prevent such an outcome from being a certainty.
Using the standard illustration technique, suppose an investment yield of 10% results in an accumulation value by retirement age of $400,000. Stochastic analysis may tell us that out of 1,000 investment scenarios, where the average return is 10% but where the annual returns may vary significantly from the average, only 80% of the scenarios will reach the $400,000 goal.
Armed with such information, what financial planning issues would the agent raise with the client? Maybe 80% success is good enough for a client, but the client might also want to know, and the agent might also want to share this with the client, that a certain percentage of the scenarios result in a materially low accumulation. This, the client might want to avoid.
See the chart for some possible accumulation strategies.
What would the stochastic approach described above do to the agents chance of getting the sale? After all, if an agents company uses this technique, wouldnt there be concern that another company not using the technique would show better accumulations?
We think not, because incorporating such techniques does not necessarily mean doing away with the initial level yield solve. What the stochastic analysis does is help zero in on the predictability of that outcome. Wouldnt a client like to know more about the likelihood that his objectives will be achieved?
Producers should take comfort in the fact that they wont have to learn stochastic techniques–because company computers and marketing guidance should provide producers with all they need in this area.
Also, computers are so much more powerful today that the time to run scenarios is a fraction of what it used to be. (The newest machine we have performs scenarios in one-third to one-twelfth of the time of older but most assuredly modern machines.)
Furthermore, one may be able to store results in an illustration system that summarizes the stochastic outcomes in a meaningful way. Thus, time responsiveness, so key to sales success, need not at all be compromised.
The stochastic modeling approach to assessing risk exposure can help planners in another way, as well. It demonstrates the planners awareness about the clients exposure to risk. In view of the shrinking account values that most investors have experienced over the last two years, that perspective alone can go a long way toward helping clinch the sale.
, FSA, MAAA, CLU, is president of Actuarial Strategies Inc., Bloomfield, Conn. E-mail him at email@example.com.
Reproduced from National Underwriter Life & Health/Financial Services Edition, December 8, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.