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November 02, 2008 at 02:00 PM
The decision to buy variable corporate-owned life insurance can entail a complicated series of steps. There are many aspects, from plan design and the desire to “fund” a plan, to the use of COLI and the insurance product costs and features. As a result, it is often tempting to try to simplify the analysis.
In the past, simplification was achieved by focusing on the insurance chassis, while leaving separate the underlying investment alternatives. The rationale was that the sub-account features are “all the same.” Yet, potentially significant differences in performance, quality and fee structure need to be addressed to ensure the client makes a responsible decision based on all available information.
Comparing rates of return
Once the client decides variable COLI is an appropriate investment, the discussions may turn to comparing the products of a few carriers. Consider an example where a broker illustrates two carriers, A and B. Using a common and quick comparison method, the broker will show the client illustrations that represent how the policy will perform over its lifetime. The crux of the demonstration is generally the internal rate of return over some period. Often, a Life of Plan IRR is used.
In Figure 1, Carrier A has an IRR of 6.2% and Carrier B, 6.7%. Given the assumed gross investment return of 7.0%, the difference in IRRs implies a difference in the total insurance costs. Carrier A’s costs are 80 basis points (bps) and Carrier B’s are only 30 bps. At first blush, a higher IRR seems to be the better deal.
However, this may not be the full story. Fees are commonly buried in the underlying investment alternatives. Not only do these fees create confusion when analyzing the true costs of the plan asset; they also potentially limit the client’s investment opportunities.
Breaking down the insurance costs may explain the performance difference and indicate hidden fees. Insurance costs can include mortality and expense (M&E), cost of insurance (COI) and loads, as shown in Figure 2.
One will note a fairly large discrepancy in the M&E numbers, while other costs are similar. This discrepancy may reveal that something is going on. When two otherwise similar COLI products have significantly different M&Es, it is usually the result of participation fees, otherwise known as revenue-sharing. The fund company pays these fees to the insurance carrier.
