“Why would I pay $8,500 for something that I could otherwise have for $4,473?”
If this price difference were about an 80-inch $4,000 ultra-high definition flat-screen TV versus a lower resolution alternative, our natural tendency would be to resolve a difficult-to-appreciate value proposition with the simple approach of lining up the two monitors and seeing what kind of (subjective) difference there is in resolution and color saturation — and then looking at the price differential. As long as the perception of relative value isn’t too greatly different, we’re generally going to opt for the lower price and pat ourselves on the back for having made a smart buying decision.
The clues for perceiving real value when buying and selling life insurance aren’t as easy to discern. Buyers know they need life insurance. Yet, according to LIMRA, fewer than half of middle-market consumers between the ages of 25 and 64 have individual life insurance coverage.
Policy illustrations provide an enormous amount of data, but are intimidating to all but those with a Ph.D. in advanced mathematics. Even if we wade through the typical 39-page indexed universal life (IUL) or variable universal life (VUL) illustration, credible information and context for deciding how to best fund these policies has been sorely lacking. The underlying volatile elements of these policies — not constant assumptions — drive the growth (or not) of accumulation value.
The heart of the issue
As it turns out, the problem of reasonably projecting a funding premium for IUL and VUL policies boils down to asking (and answering) this question: What’s a reasonable long-term rate for the purpose of these calculations?
Insurance companies and their illustration software will allow a projection rate as high as 12 percent gross of expenses on behalf of VUL illustrations, and it’s not unusual to see upper limits of 8 percent or more with which to project IUL values. And while carriers and broker-dealers may offer recommendations based on an historic look-back at equity returns (typically through the S&P500 with dividends for VUL and S&P500 without dividends for IUL), there’s a powerful reason to choose crediting rates at the higher end of those allowed by the illustration system.
And the reason is simple: The higher the chosen projection rate, the lower the calculated planned premium or the calculated future “cash flow” withdrawals and loans that may be sought by the policy owner. But, of course, these are merely projections.
Or as the typical illustration disclaimer suggests: “This is only an illustration. An illustration is not intended to predict actual performance. Interest rates, dividends, or values that are set forth in the illustration are not guaranteed, except for those items clearly labeled as guaranteed.”
OK, I guess a reasonably intelligent person understands those words. But the words do not help us appreciate that the premium is not guaranteed.
And there is a 0 percent likelihood that the policy’s calculated planned premium will sustain to age 100, an age to which many healthy women in their mid-40s aspire. Assuming, alternatively, a life expectancy of age 90, the policy’s non-guaranteed, calculated “low price” has only a 13 percent chance of sustaining long enough to pay an age 90 death benefit.
We can’t resolve this dilemma with the conventional information and printouts provided by insurance companies and agents. But we can apply supplemental tools that provide meaningful information to consumers and their non-insurance advisors so they can make smart decisions that are in their best interest.
A reasonable long-term rate
As we observed in “Buddy, Can You Paradigm?,” the $4,473 planned premium calculated for a 43-year old healthy woman’s $1 million IUL policy looked good in the illustration; in fact, the account value appeared to grow to equal the death benefit should she live to age 100.
Thereafter, we noted that a planned premium more likely to produce the lifetime death benefit she wants should be $8,500 — not $4,473. The appropriate illustration is run and signed (this time with 5.18 percent rather than 7.6 percent assumed crediting rates).
But notwithstanding a nodding of heads and possible signing of a premium check, we can count on this phone call within a 24- to 48-hour period: “You know, I’ve been thinking about it, and I’d rather pay the $4,473 and take my chances on outliving the policy.”
In the language of sales training, that’s called “buyer’s remorse.” It’s a natural phenomenon in which everything but the price difference has been forgotten. And in the absence of that elusive information, price is now the paramount differentiator.
It’s too bad that neither the insurance producer nor the client’s non-insurance advisor thought to prepare her for the inevitable forgetting of key points — and being left only with the sense of having paid too much.
Let’s re-write the script. After carefully explaining that while the $4,473 isn’t going to sustain the policy, our initial estimate of $8,500 is just that — an estimate. We don’t have a crystal ball; we don’t know how future equity markets will perform.
Over time we will monitor the policy for actual performance of the index and its effect on the accumulation account. And we will likely make modest adjustments (upward or downward) in the planned premium recommendation. We will also provide after-sale service and the client will become confident over time that she has made the right choice of agent and planned premium for her policy.
The following is what I would write on a note accompanying each of the two illustrations:
Illustration #1 with a calculated planned premium using 7.6 percent as the assumed crediting rate: “Using what appears to be a reasonable back-tested average rate of return as the calculation rate to answer your cost question, the resulting policy illustration provided an attractive planned premium recommendation of $4,473 for the $1 million policy you have purchased. However, when we exposed that planned premium to a calculation of random volatility in 1,000 hypothetical illustrations, we discovered that, statistically, the $4,473 planned premium is unlikely to fund this policy through your average life expectancy.”
Illustration #2 with a calculated planned premium using 5.18 percent as the derived crediting rate from the Historic Volatility Calculator: “Using a crediting rate assumption of 5.18 percent, which is expected to compensate for the volatility of returns in your chosen Index, we initially estimate a planned premium of $8,500 to adequately fund this policy for your entire life.
This number may turn out to be a little high or a little low, but today it appears a reasonable guess. We will review this policy every 2 to 3 years and help you revise your planned premium based on how the Index and your policy are actually performing.”
Then I would place both sets of illustrations and their accompanying notes into a file to leave behind with the client and write in large red letters: “In case of Buyer’s Remorse, open this file first!”
It’s important to point out that this is not about one IUL or VUL being “better” than another. Or of one policy having an inherently lower premium than another. Because when it comes to current assumption UL policies, there is no premium. In a real sense, we make up the premium — a planned premium — and give no further thought to it, other than a desire to make it as low as possible.
With a particular planned premium, it’s the lifetime credits and debits of the policy that will be the ultimate measure of success or failure. We need to help clients appreciate that fact and give them a credible basis to determine the appropriate premium for their circumstances and needs. The HVC (an exclusive benefit of membership in the Society of Financial Service Professionals) will accomplish this simple but hugely important task.