Cost Competitiveness of Life Insurance

Barry D. Flagg, CFP, CLU, ChFC

Inventor and Founder of THEInsuranceAdvisor.COM

Cost competitiveness of life insurance policies is an obvious determinant of suitability. Keeping costs low is critical because every dollar spent on expenses is one less dollar available to purchase more death benefit. In fact, a recent study by Morningstar revealed that “Low fees are likely to be the best predictor of a mutual fund’s future success”[1], and the same certainly holds true for life insurance products.  While different insurers refer to different policy expenses in different ways, all policy expenses in all life insurance policies fall into the following 4 categories: 1) cost of insurance charges (COIs), 2) fixed administration expenses (FAEs), 3) cash-value-based “wrap fees” (e.g., M&Es) and 4) premium loads.  Each type of policy expense and its role and relevance in pricing and suitability is discussed below.

Cost of Insurance Charges (COIs) – The largest single cost in any insurance product is the cost of paying claims. Charges within life insurance policies collected to pay death claims are referred to as the Cost of Insurance (COI) charges. COI charges can account for 75% - 85% or more of the total policy expenses. Given findings from independent studies^[2] indicate there can be as much as a 40% deviation between best-available rates and average pricing terms and then also between average pricing and poorly-priced products (an 80% swing in total), measuring COI charges is an essential part of any policy review and/or suitability determination.  In addition, some insurers "load" COIs to cover expenses not disclosed elsewhere (see discussion of "no-load" or "low-load" products under Premium Loads below).

Fixed Administration Expense (FAE) – FAEs are typically charged for expenses related to actuarial design, underwriting and new business processing, and service and administration, and are calculated as some fixed amount set at the time of policy issued either as a flat monthly charge (e.g. $10.00 a month), or in relation to the originally issued policy face amount (e.g. $1.00 per $1,000 of policy face amount). Also, with the advent of Guaranteed Universal Life products, FAEs often include the costs of death benefit guarantees.  FAEs can also include contingent or back-end surrender charges deducted from the policy account value upon surrender or cancellation/termination of the policy. These surrender charges are calculated in relation to the initially issued policy face amount and can be as much as 100% or more of the planned annual premium. 

 F A E s C O I s

Cash-Value-Based “Wrap Fees” – Cash-value-based “wrap fees” are insurance fees charged as a percent of policy account values similar to Fund Management Fees (FMEs) that are also charged as a percent of assets under management. However, these cash-value-based insurance fees are specific to the policy, and separate from and in addition to investment fees. The most common cash-value-based fee is the Mortality & Expense Risk (M&E) charge found in variable life products and intended to cover the risks assumed by the insurance company that actual cost of insurance charges and/or actual expense charges will be greater than expected. On the other hand, because investment fees are specific to the various mutual-fund-like separate accounts to which cash values are allocated, which almost certainly will vary over time, FMEs are less a determinant of life insurance product suitability and more relevant to fund selection within that product.

Premium-Loads – Premium loads are calculated as a percent of premiums paid in a given year and typically range between 0% and 35%. Premium-based charges customarily cover state premium taxes that average 2.50%, DAC taxes averaging 1.5%, and Sales Loads/Expenses typically ranging between 0% and 30%. Policies that are marketed as "no-load" or "low-load" policies do not disclose certain policy expenses or loads. However, because certain premium based loads still must be collected (e.g. state premium taxes, federal deferred acquisition costs (DAC) taxes, and the cost to distribute the policies), some insurers assess these costs inside "loaded" COIs.  A load by any other name is still a load, no matter where in the expenses it is recorded.

While different insurers may use different words to describe the same type of policy expense, the expenses in all life insurance products are either a cost of insurance charges (COIs), a fixed administration expenses (FAEs), a cash-value-based “wrap fees” (e.g., M&Es) and/or a premium load.  Altogether, it is these expenses that are one of the five major factors to consider when investigating the suitability of a life insurance product.