A nostalgic view of our cornerstone product-evolution
by Richard M. Weber, MBA, CLU, AEP (Distinguished)Mr. Weber is President and primary consultant for The Ethical Edge, Inc., providing fee-only analytics and consulting services to family offices and high net worth individuals. For 25 years a successful life insurance agent and 20-year life member of the Million Dollar Round Table.
Baby Boomer nostalgia takes many forms: the ’57 Chevy Impala convertible my mother let me drive every now and then; the incredible smorgasbord of music that began to emerge in the mid-50’s; and for this 50-year veteran of the life insurance business – the TV show Father Knows Best (1954-1960) .
That’s because Jim Anderson, the ideal father and solver of all problems in 22 minutes, had a screen career as a life insurance agent. The show’s producers appreciated that he could more reasonably be seen around the house during the day without the conflict of a nine to five desk job.
I also have nostalgia for the life insurance products sold during my first 10 years in the business: Five-year term and whole life. The term was ridiculously expensive and the whole life was based on a very conservative 1954 “CSO” mortality table, but when the whole life fit a client’s needs and resources, I didn’t have to be concerned about how long the policy would “last.”
It had a guaranteed premium; dividends “always went up,” and whole life also had a reasonable long-term savings element. I probably fell a little short on Jim Anderson’s idealized parenting skills, but he and I would agree we were providing quality insurance products to our clients that were designed to protect a family for the insured’s lifetime.
A New Life
Current assumption universal life products were introduced in the late 1970s and “life” was never the same again. Making substantial inroads on whole life sales by the mid-1980s, UL was pitched as the ideal life insurance product. It transparently displayed all its moving parts, it took advantage of the historically high interest rates of the late 70s and early 80s (14 percent crediting rates were monetarily available in some products), and from a pricing standpoint – it seemed a much less expensive alternative to whole life.
There was just one little problem – illustrated performance almost never happened the way it was portrayed, and more and more anecdotal evidence suggests current assumption policies may not sustain even to average life expectancy for a number of policies sold in the last 35 years.
Policy illustrations are certainly problematic when suggesting minimum premium outlay expectations than can’t reasonably be met, so we need to look at the underlying economic factors that drive both current assumption and guaranteed life insurance products.
The whole life products of Jim Anderson’s era existed in a post-war, expanding economy and growing equity markets that also maintained relatively stable interest rates. This is the ideal economic environment to offer and support guaranteed premiums for lifetime coverage.
Contrast the economy of the 50s and 60s to our current experience: the lowest fixed return interest rates in more than half a century and a 2008 stock market scarily reminiscent of the 1930s Great Depression era. Today’s economy is not for the faint of heart – and today’s life insurance products are in need of a redesign that can be reasonably profitable for the carriers and meet the needs of consumers who are increasingly recognizing the need for stable pricing, if not guaranteed pricing.
In my experience, today’s “X” and “Y” generation consumers want less volatility and more guarantees in their insurance products—and they want policies to last their lifetime. At least within current popular product offerings designed for lifetime uses, we can explore how to meet these objectives with Indexed Universal Life (IUL), Guaranteed Death Benefit UL (GUL), and Whole Life (WL).
IUL has become a very popular lifetime product choice since the market recovery began in early 2009, and initially appeared to have an ideal approach to providing a “floor” return while capitalizing on at least a portion of favorable equity returns. But, as with all current assumption policies and their illustrations, IUL has issues.
There is an inherent inability for a linear policy illustration to demonstrate the negative interaction of minimum planned premiums with collared volatility (the movement of crediting rates between the typical zero percent minimum guarantee and the current rate Cap – typically 11 to 12 percent).
For example, a major IUL carrier’s policy illustration for $1 million on a healthy 47-year old male solves for a lifetime annual premium of $8,797 (“endowed” account value at age 100) with an “AG49” maximum 6.48 percent crediting rate. Yet when further assessed based on volatility within the “collar” of 0 and 11 percent, the proposed coverage has just a 66 percent chance of sustaining to the client’s age 100.
If we speculate that the current Cap may not remain at the current 11 percent level, we can further evaluate just a 46 percent probability of sustaining to age 100 when assuming a lifetime 10 percent Cap. These results are derived from Monte Carlo assessments in which we generate 1000 hypothetical illustrations using randomized, historic S&P500 one year point-to-point returns.
Our studies suggest it would take $10,000 a year (vs. $8,797) to raise the probability expectation to 90 percent for a 10 percent earnings Cap assumption. A similar premium “solve” could be achieved by specifying a lifetime crediting rate of 5.11 percent, compensating for collared volatility within a traditional policy illustration.
By contrast, a major carrier’s GUL illustration indicates a minimum $7,769 premium for the same hypothetical 47-year old healthy male. While we seem to have achieved a more favorable outlay and a guarantee of sufficiency to age 120, we must remind our clients there is no flexibility with respect to the amount or timing of premium payments.
Also, there is no accrual of cash value throughout the years of coverage; GUL by design generally has no sustaining long-term cash value accumulation. The good news: everything about the policy is guaranteed (subject to the full faith and credit of the issuing carrier) as long as the guarantee is scrupulously maintained and managed by both the insured and his agent.
However, depending on the needs and age of the client, the fixed death benefit inherent in a GUL policy may not be sufficient, on an inflation-adjusted basis, for a policy benefit that may not be triggered for another 50 years; three percent average inflation would render a $1 million policy worth just $228,000 in that timeframe.
At the other end of the spectrum, whole life offers both strong guarantees and considerable cash value accumulation with the payment of all required premiums, but comes at a high initial premium outlay that only a relatively few consumers can “afford” for all their protection needs.
Our hypothetical client would expect to pay $17,780 for a $1 million dollar policy. With today’s historically low dividend projections based on eight years of sustained low interest rates on fixed return investments, the death benefit could be expected to approach $2.6 million at age 100 with the current scale of dividends acquiring paid-up additions. Of course, while premium, cash value and death benefit is guaranteed in a whole life policy, dividends are not guaranteed. They can and will vary as economic conditions and carrier experience accrues over time.
Each of the lifetime policy options has its strengths and weaknesses. Until or unless a new design for life insurance comes along, our best hope for sustainability, guarantees, reasonable outlay expectations, and accrual of cash value – will likely come from some combination of the major lifetime-designed policy styles.
In one example of a self-contained combination, for example, The Guardian Life Insurance Company of America (Guardian) now offers a rider to many of its whole life policies, giving policy owner’s the flexibility to allocate all or a portion of each year’s paid dividend into an indexed account.
Called an “Indexed Participation Feature” (IPF), this option incorporates the substantial guarantees of the underlying whole life policy and the potential for “IUL-like” results with less risk than a standalone IUL policy. Where the typical IUL has a 0 percent guaranteed floor and a non-guaranteed cap currently averaging 11 percent (3.5 percent guaranteed) – Guardian’s IPF has a four percent guaranteed floor and a current cap of 12.5% – and a guaranteed minimum cap of eight percent.
There is a one-time expense charge of two percent of the value of the allocated dividend. In the whole life example cited above, fully allocating dividends to the IPF could result in a non-guaranteed death benefit at age 100 – projected at allowable AG49 illustration rates – of a little more than $3 million.
For product recommendations that don’t include a built-in opportunity to diversify how a policy sustains itself while providing guarantees and flexibility, agents and advisors might approach their client’s needs the old-fashioned way: a customized policy allocation in which risk tolerance drives a recommendation for certain proportions of uncorrelated policy styles for optimized results. In other words, a custom-designed portfolio of policies.
For example: with a client claiming a mid-range risk tolerance (more than conservative but less than aggressive), a $3 million lifetime need for life insurance could possibly be met with 50 percent whole life, 25 percent GUL, and 25 percent IUL – especially if the client has well-funded existing GUL or IUL already in place. This specific blend of policies could allow for substantial cash value build-up, management of premium guarantees, and upside potential.
Depending on the client’s portfolio and earned income, at least a portion of premiums can be paid (i.e. allocated) out of appropriate asset classes of portfolio resources. Long-term returns of intermediate (five year) duration U. S. Treasury Bonds netted an average 1.54 percent from 1985-2014 (net of fees, taxes, and inflation – according to Thornburg Investment Management) and high-grade corporate bonds fared little better at 1.93percent. A whole life policy assessed in the same 30-year time period had a similarly calculated internal rate of return of 2.43 percent after inflation, in consideration of premiums paid compared to total cash value (including the cash value of paid-up additions).
In this approach we’re treating life insurance cash values as an asset that is uncorrelated to the typical accumulation-oriented investments in a portfolio. Life insurance isn’t in competition with fixed-return assets but rather is in a “collaboration” with similar asset classes. This includes achieving a form of double-duty out of portfolio resources allocated to life insurance cash values. This can assure the stability of the portfolio, provide needed long-term death benefits, and in typical cases actually somewhat increasing the overall return of the fixed-return portion based on the cash value build-up.