Appraisals of life policies are hot right now. That’s because the value of life insurance products has not gone down in this rough economy; it has even gone up, like the end of the see-saw, when everything else goes down.
Insurance professionals can use appraisals to do the right thing for their clients, who need to know the value of what they own. They can do the right thing for themselves, too, because of the opportunities that arise in the appraisal process.
There are numerous purposes for an appraisal. Examples might include: helping to decide whether to retain a policy, change a policy or sell a policy in the secondary market; or needing to value a policy for an estate or trust.
Such uses of an appraisal can present opportunities including coverage enhancement, encouragement of retention, and help with financial planning.
The process applies to the wonderful array of life policies written in the past which are now valuable assets that need to be evaluated using an appraisal. The variety of need for this service is astonishing, as the chart makes clear. All of the situations shown in the chart create opportunities. (This article does not examine the specifics of each situation–industry professionals can take care of that.)
What about the appraisal process? It’s quite straightforward. It’s just a matter of taking the present value of the future benefits, and subtracting the present value of the future premiums. Sounds simple, but there are a few crucial procedures:
1) Start with an appropriate in-force illustration. To maximize the appraisal value, it’s best to minimize the premiums to achieve lifetime benefits. In other words, overfunding does not necessarily help increase an appraised value.
2) The most important step is determining the current health of the insured; this affects the mortality rates used to determine those “present values.” It’s important to get this right.
3) A proper appraisal should be done twice: once using guarantees, and once using illustrated values. Then balance between the two results to arrive at a final appraisal. More weight should be given to the illustrated values for companies with greater financial strength. (This, incidentally, is a way to answer the question: What if the company doesn’t live up to its illustrations? It’s a matter of coming up with the odds.)
4) Decide on the interest rate to be used in discounting the present values. A lower rate increases the value. That’s why current low yields have increased the appraisal values of existing products. To show the value of the policy to the owner, it’s probably best to use a rate that is reasonable, definite, and non-controversial–e.g., a 10-year Treasury bond yield (3.625%, as of mid-November) or some other rate the policy owner feels he or she can safely earn on investments. (Perhaps it’s occurring to readers that a life settlement investor, who expects to earn a much higher rate of return, could vary the interest rate assumption, accordingly.)
Real estate appraisals may come to mind as similar procedures. There are similarities. Methodologies are definite in both cases. But each individual appraisal is unique. Intangibles exist in both cases, but the basic appraisal is still indispensable.
What does a typical policy appraisal look like? At the moment, I am looking at a $4 million policy on an 80-year-old nonsmoker male with fairly serious health problems. The appraisal is $1,360,000. (The current cash value is zero.)
Appraisals are boosted not only by low current interest rates, but by the very favorable policy options and features contained in the products. As an example, I recently came across a policy with guaranteed life insurance values based on 5.5%. Not a bad rate these days–and it’s tax-deferred also.
So right now, it’s a good time to be sitting on the top end of that see-saw, especially since a life insurance professional can stay up there.
John M. Bragg, FSA, ACAS, MAAA, is actuarial consultant at Bragg Associates, Atlanta; past president of Society of Actuaries; and past CEO of Life Insurance Company of Georgia. His e-mail is firstname.lastname@example.org.