“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).