We discovered a way to compete and win in the world of illustration warfare.
We were presented with a case from a financial advisor who was competing against a major carrier’s indexed universal life (IUL) policy illustration that was packaged as a life insurance retirement plan (LIRP).
In our opinion, the interest rate used in the illustration was aggressive. However, we do not wish to tell you how you should be running or presenting client illustrations. Instead, we want to help you compete against these aggressive illustrations. We also want to give you some things to think about as you and your prospects discuss planning opportunities that involve life insurance projections.
Before getting into the specifics of that competitive situation and the tool that we used to educate the advisor and the client, let’s remember the basics of how life insurance illustrations are used to project future policy values.
There are two broad types of illustrations (and here, let’s focus on UL insurance): (1) sales illustrations used in the initial sales process to help explain a policy; and (2) in-force illustrations that reproject a policy after it has been placed in force. As insurance professionals know, an illustration is an approximation using assumptions that may or may not occur. That is a fact — just as you cannot predict with any degree of certainty what a 401(k) plan account will be at retirement, you cannot accurately predict how a UL insurance policy will perform in the future. Assumptions are just that — assumptions.
To frame the discussion, above is a chart of the 10-year Treasury rate as of Dec. 15, 2014.
This chart is instructive in that the bulk of a carrier’s investment portfolio, which drives both returns and options pricing for IUL products and thus crediting rates, is invested in 10-year Treasury bonds. Life insurance crediting rates reflect, to a certain extent, the ups and downs of the economy with some lag due to the long-term investment nature of bonds. The important aspect to note here is the sequencing of returns. This chart has ups and downs. And so do the crediting rates of insurance carriers. A problem occurs when you project a flat (and typically high) rate of return and expect that sequencing to persist.
In the 1980s, UL products were illustrated at 10-12 percent. In the 1990s, variable universal life (VUL) products were illustrated at 10-12 percent. IULs now are being illustrated at 8-10 percent. In hindsight, the UL and VUL illustration rates now are considered very aggressive and have led to client disappointment and dissatisfaction. Are we repeating an unhappy history with our high IUL illustration interest rates?
One conclusion from the crediting rate conundrum could be “Don’t buy life insurance.” Another could be “Buy term and invest the difference.” The lesson is, however, that an educated consumer is a happy consumer. The more clients know about life insurance and how it really works, the more they will appreciate life insurance and respect the advisor who educates them.
With that background, here is our LIRP fact pattern:
1. Male client age 48
2. Preferred rate class
3. $24,000 of premium per year for 19 years (to age 66)
4. Option 2, minimum non-MEC (Modified Endowment Contract) death benefit, then Option 1 thereafter
5. Taking distributions of $116,389 per year starting at age 67 for 20 years (withdrawal to basis, then loans thereafter)
6. The income solve included the objective of keeping the policy in force to age 120 (minimum cash value)
As we reviewed the illustration from this major carrier and tried to compare it to other products, we realized that the return assumption on the IUL illustration was 9 percent. That is not a typo. Nine percent! Referring back to the chart, do you see a consistent 9 percent sequencing of returns? No, you don’t. And your prospects and clients won’t either.
However, although we knew that, we needed a way to compare “apples to apples” and to help the client understand the impact of illustrated interest rates. Toward that end, we recently had heard about a tool that can help assess the viability of a proposed planned premium. This tool is a generic planned premium testing device that provides useful guidelines and benchmarks for situations in which a planned premium is not fully guaranteed to maintain a policy in force for life — such as UL, IUL and VUL.
There are other ways you can assess the reality of an illustration, such as running multiple illustrations at deferring interest rate assumptions. But the tool we employed uses generic product standards as a way to normalize differences in policy expenses. This tool allowed us to independently test the lifetime sufficiency of a planned premium. Further, we believe that such a planned premium assessment and recalculation help the advisor communicate a rationale for an amount of initial planned premium that will be managed over the insured’s lifetime. This is similar to how pension actuaries advise their clients on the funding of a defined benefit pension plan. You start with an initial expectation and then manage the contribution on the basis of ongoing results and experience.
First, performing such an assessment recognizes that a permanent life insurance policy is a financial investment that must be managed. Second, life insurance can be analogized to a retirement plan. This analogy is appropriate both from what a life insurance policy can do for a client (provide a pool of assets to tap for retirement) and how a policy can be affected by economic factors.
Much has been written about the linear nature of life insurance illustration assumptions inherent in products that do not provide linear returns, especially IUL and VUL products. The life insurance industry uses linear returns to help explain the possible outcome of an insurance plan or strategy, but products such as VUL and IUL are anything but linear. The tool we employed uses the process of historic rate randomization to estimate the success probability of an illustration as opposed to the linear nature of the tools used by insurance company software. It runs 1,000 different scenarios to provide results. It is a terrific illustration reality check and a great educational tool for clients and prospects.
This article is not intended to provide a detailed explanation of the tool we used. For purposes of this article, it is sufficient to know what the end game is: the probability of success of a set of assumptions in an illustration.
So let’s go back to the 9 percent illustration with $24,000 of premium and $116,389 of supplemental income for our 48-year-old prospect. We ran our tool with the illustration assumptions provided by the advisor and, no surprise here, the success probability of this scenario was zero. Zero!
Our next step was to request the same illustration from the carrier using a 6 percent return and solving for income to produce the same cash value result at maturity. The carrier illustration produced an income solve of $54,538, and the tool produced a success probability of 56 percent. So basically, the advisor is asking the client to “invest” $24,000 per year or $456,000 over 19 years to get a “coin toss” result on this retirement income supplement strategy. Would your client like those odds? Probably not. More important, does your client even understand that these illustrations are projections that will vary significantly depending on future performance?
Perhaps you would want to ask this prospect if he or she would be willing to sign off, accepting that the possibility of success is either zero or 56 percent. “Just for my files,” you say. Alternatively, you may want to have your prospect share the results and have your competitor produce an illustration that has a higher probability of success. You can tell your prospect, however, that there is good news!
We took another leading carrier’s IUL product and ran it at five different interest rates to illustrate how dramatically the selected interest rate assumption can impact the probability of success. Here are the results.
So does your client want a 9 percent chance that his LIRP will actually pay out the stream of payments projected? Or an 86 percent chance? Using this tool, you have a definitive way to show your clients the impact of the illustrated rate assumption, and together you can make an educated decision about which interest rate assumption to use.
Today, transparency is the coin of the realm — and can make the difference between making a sale and not making a sale.
In our brokerage general agency, we see product illustrations every day, we see hundreds of them every week, and we are constantly amazed at what advisors are showing clients. As an industry, have we not learned the lessons of UL in the ’80s or of VUL in the ’90s? If we have not learned these lessons and continue to illustrate IUL at 9 percent with low premium solves and/or lofty income streams for clients, then we are doomed to continue to disappoint clients and not meet their expectations. Further, we hurt our own industry, diminishing the confidence in the great value that a well-designed life insurance program can deliver.
We have found that using this tool is invaluable in helping advisors bring real value and meaningful expectations to clients instead of showing illustrations that we know will never deliver the illustrated results. The results and reports can reside in your client’s file to demonstrate your due diligence. You can then rerun the illustrations and the assessment tool every three to five years to continue to manage your client’s life insurance investment. Of course, this also gives you a reason to meet your client to review the results and, perhaps, sell other financial products.
Clients and prospects are desperate for great advice. Producers who offer great advice using innovative tools will not just survive — they will thrive. Competing on illustrations using the interest game is a recipe for disaster. Competing as a thoughtful, consultative producer will result in educated, happy clients and lots of future referrals.