A perceived difficulty in comparing variable products is deciding what a reasonable assumed illustrated return on your investment should be. Whether you decide that your aggressive investment mix warrants a 12% assumption, or your conservative approach is at 4% or even 0%, the use of assumed rates to compare policy performance often doesn’t matter.
The purpose of looking at variable life projected values is twofold: to look at the nonguaranteed (expenses, cost of insurance), and contractual (surrender charges, guaranteed values). The most important function an illustration can perform is to show what impact current and guaranteed charges and expenses have on your assumed rate and consequential gross (before expenses) values.
When it comes to nonguaranteed illustrations, it obviously doesn’t make sense to use a 12% assumption for a client whose risk profile warrants a money market or Treasury bond subaccount investment mix (they probably shouldn’t have a VL policy anyway). The only thing we may have learned from the last year or two of equity subaccount performance (where investors who realize positive long-term gains invest) is that the current assumed rate just doesn’t matter. The impact of your expenses and charges on whatever rate you use is the most important function of the illustration. Actually assuming, or worse, influencing a client to assume the rate on the illustration is close to what they will experience in the near to mid-term, flies in the face of historical fact.
For quite a while when gathering illustrated values for inclusion in the Full Disclosure VL databases we requested values based on a 10% net of average subaccount expenses and current (nonguaranteed) policy expenses. When investment experience started to decline for many subaccounts we were encouraged to drop the assumption to 8%, which we did last year. It is reflected in the charts included with this excerpt. When a class of subaccounts is experiencing annual returns in the negative double digits, it reinforces the fact that it usually doesn’t matter what your assumption is, as long as you accept the fact that it’s not real.
Full Disclosure surveys variable insurers twice each year and tracks illustrated values and the benefits each brings to the marketplace. In addition to the contractual and qualitative data on each policy collected, we also look at how they are illustrating their products in the field (current as of September 1, 2009). There are charts for current illustrated values and a scenario with maximum retirement income-an ideal use for VL. There is also a guaranteed minimum premium excerpt for long-term (age 100 or lifetime) guaranteed premium and death benefit.
Current illustrations are based on a Male Age 40 paying a $7,500 annual premium and a $1 million policy. Subaccount expenses can be either arithmetic, or more likely, weighted to the largest subaccounts available in the policy. Look at the footnotes at the bottom of the main chart. More details regarding how illustrations are derived and other information, such as the number of issue classes available for each policy, are available in the software release of Full Disclosure.
If our specified premium of $7,500 is too low to illustrate the policy for this age and face amount, the policies are blended with term insurance if available. The death benefit type is level; however, a column is included with a true increasing death benefit for each policy. The class specified is best nonsmoker as long as the class represents at least 15% of the contracts issued of each policy.
Internal rates of return (IRR) figures, included in the main chart, indicate which products are designed to be more efficient in producing cash values, death benefits, or are an all-around solution. The IRR can be applied to cash values as well as death benefits, and we have chosen to measure both at a policy duration of 30 years. Those seeking to analyze the relationship between cash values and death benefits will find the IRR measurement a useful tool. Information is included to show you what the death benefits would be illustrated under an increasing death benefit option.
Variable life is also marketed as a tool to supplement retirement income. This is done by surrendering accumulation values to the contract’s cost basis and using policy loans thereafter, or increasingly, by using only loans to provide maximum income. In the accompanying retirement income table, companies were asked to illustrate policies using a $10,000 premium starting at a male’s age 40, selecting an increasing death benefit option until age 65. At retirement, age 65, the death benefit type is switched to level as values are liquidated. A residual value of $100,000 was requested at the policy maturity age and companies tried to come as close to that as their illustration systems would allow. Again, certain policies are designed to do certain things and a high cash value at age 65 does not necessarily translate into high retirement income.
The guaranteed minimum premium excerpt is for long-term (age 100 or lifetime) guaranteed premium and death benefit. Whether by rider, a minimum premium level, or through a dedicated fixed account, mechanisms to include the guarantee may differ. If a policy is not featured in the minimum guaranteed premium chart, it does not offer a long-term secondary guarantee but may offer shorter guarantee durations as specified in the main chart featuring illustrated values.
The illustrations in this report are meant to show how individual life variable plans are being illustrated on the street as a way to gauge their relative positions for a sample policyholder. The real product differentiation is at the policy level in the features, limitations, and current and guaranteed cost structure of each. While it is tempting to try to compare products using subaccount performance, the real test of a product’s ability to create policyholder value lies with the contract, or the “wrapper” around the investment components. To help clarify what each product in this report is designed for, we have included information under Product Design Objectives.