What’s the right crediting rate to assume in a variable or indexed universal life (IUL) policy illustration? If a long-term view of the Standard & Poor’s 500 has been 6.5 percent (without factoring in reinvested dividends for the 59-year period from Oct. 1, 1955, through Sept. 30, 2014), is that the appropriate starting point to answer the question?
The issue has been addressed several times in this column. It’s not only insurance agents who must wrestle with the answer. Attorneys, accountants and financial planners are interactively involved with their clients on many issues, and the sufficiency of a life insurance policy is as important to these non-insurance advisors as it is to the insurance agents who sell and service those policies.
The National Association of Insurance Commissioners (NAIC) also is concerned that constant rate illustration projections seem to inherently substantiate the illusion that a policy can be fully supported with crediting rates in the 6.5 percent to 8.25 percent range. The NAIC’s Life Actuarial Task Force has examined different perspectives in reviewing a number of proposals presented at its fall 2014 meeting. The task force has fast-tracked its review and is targeting July 1, 2015, as the date after which new IUL illustrations must conform to specific regulations limiting illustratable crediting rates.
Unfortunately, there is not a single point of view concerning the extent to which limitations should apply. The competing factions fall into several broad camps, which are typically focused on those insurers who sell IUL and those who do not. Several major mutual carriers have proposed that illustratable rates should be tied more specifically to historic returns. Among other things, they recommend that numerical calculations provide a three-tier result based on:
Guaranteed expenses with guaranteed crediting rate
Current expenses with the midpoint of the maximum allowable crediting rate
Current expenses with an agent-selected rate not to exceed the maximum allowable crediting rate.
The determination of a (pardon the pun) universal solution is elusive. There is the issue of appropriate illustration credit rates, and how agents and consumers can understand a three-dimensional product with many moving parts when viewed in a complex two-dimensional 47-page policy illustration. Another concern is presenting an understandable way to address the reasonable expectations agents and their clients may have regarding how cap rates can fluctuate between the level guaranteed in the policy (typically between 3 percent and 4 percent) and the current rate (for which 12 percent is typical among major carriers). It is questionable whether the following formula – attempting to assess the expected return on a call option underlying a carrier’s cap-setting process – could help!
Most commentators have missed the point. In early December 2014, the Society of Financial Service Professionals (FSP) submitted a preliminary commentary to the NAIC. While other submissions focused on how to limit illustration crediting rates, FSP provided examples stemming from its Historic Volatility Calculator (HVC). Insurance professionals understand that illustrated crediting rate scenarios do not help agents and their clients form a meaningful expectation about how inherent crediting rate volatility may affect their “premium” choices over the insured’s lifetime. HVC is a supplemental analytical tool that takes the calculated planned premium from an IUL sales illustration and then further calculates 1,000 hypothetical illustrations utilizing randomized, historic point-to-point returns in order to test the likelihood of the illustrated planned premium sustaining the policy to the insured’s age of 100.
Results for a 47-year-old male in great health seeking a reasonable planned premium for $1 million of lifetime coverage in which the agent initially utilizes a 6.75 percent crediting rate assumption.
Planned Premium: $8,568 with nominal cash value at age 100
HVC Success Probability: 477 out of 1,000 (12% assumed lifetime cap) or 67 out of 1000 (10% assumed lifetime cap)
Initial Recommended Illustration Rate: 5.85% for a $10,000 revised planned premium (90% success probability)
The NAIC’s task force chairman has indicated that the focus on illustration rates will be only an interim step (ideally to be completed in March 2015), with the task force then opening up the basic life insurance illustration model law for revision as a long-term goal.
For several years, FSP’s Illustration Questionnaire Committee has brought together product experts, academics, actuaries, agents, and consumers to consider conceptual uses of technology such as digital tablets to bring a multidimensional and visual approach to answering that fundamental question: “How much will it cost?”