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Value Of Life Insurance: Back To Basics

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Reviewing the process that an insurance broker went through to select a life insurance policy for an individual became an eye-opener.

There are lots of decisions to make and many product options to consider.

The individual’s attorney and tax advisor had outlined the client’s insurance needs. Now in his 70s, the man needed a policy that’s guaranteed to pay $20 million at time of death. He didn’t need cash values, nor was he interested in ever selling the policy in the secondary market.

It was refreshing to work on a project in which the client simply wanted to buy life insurance for the death benefit and nothing else. (This is in contrast to the dominant focus today, which is on trying to enhance products in ways that complicate matters, such as adding different crediting rate strategies and a plethora of riders.)

The step-by-step process that emerged should be helpful to anyone facing such requests.

Step 1: The first step in the agent’s process was to select the right type of insurance. Considering that one criterion was to obtain the lowest premium to buy a guaranteed death benefit, the obvious choice was a secondary guarantee universal life policy (SGUL). However, the agent considered other products too–e.g., whole life with a level term rider and traditional UL–to make sure the SGUL was the right choice. The WL with level term rider tended to have slightly higher premiums; as for the traditional UL, while it allowed for lower premiums in the early years, the premiums in the later years more than offset them.

Step 2: Next, the broker made sure that the client received the lowest premium rate. A quick check of several rankings of SGUL premium rates produced the initial list of companies. Then the agent discussed the client’s medical information with company underwriters to ascertain expected underwriting class. When several insurers responded that the client was either uninsurable or substandard according to their guidelines, this further reduced the field of possible candidates.

Step 3: The agent made sure the companies left on the list were financially strong. Fortunately, the insurance industry has several excellent rating agencies to review insurer claims-paying abilities. This allowed the final choice to be the lowest premium SGUL, for the expected underwriting class, from a very well respected and financially strong company.

Step 4: The agent’s final step was to demonstrate the return on the life insurance product purchased by the client.

The challenge: The insurance industry is built around the law of large numbers and each insurer is reasonably comfortable about the return it will receive by selling thousands of insurance policies. However, individuals have no way of knowing the value of their policy, since this value depends on an unknown event (the person’s date of death).

The strategy: There are several ways to look at the value of a life policy for a given policy owner. The simplest is to realize that the family or business needs financial assistance at the time of the policyowner’s death. If proper analysis has been done to choose the best policy and insurers, there really is no need to place a numeric value on the insurance policy.

However, say there is interest in looking at the numbers. In that case, using a pricing mortality table and a 5% interest rate, one can show that the client, in this example, can expect the accumulated premium to exceed the death benefit paid after policy year 14. If death occurs before the 14th policy anniversary, the return is higher than 5% and anything after year 14 produces a lower return.

There is an 80% chance that the death benefit paid will exceed the premiums paid into the plan and a 50% chance that the rate of return on the policy will be at least 5%. The chart shows the rate of return for policy years 4 through 20, assuming that death occurs at the end of that policy year.

In the end, the client in this example was very well served by the broker who put forth a lot of effort and thought to make sure the client received the best possible life insurance policy. With a trust set up to make sure premiums are paid on time, using a product with a guaranteed lifetime benefit and a financially strong company, the policyowner can be assured that the benefit will be paid at time of death.