THEInsuranceAdvisor.COM is pleased to announce the posting of Suggested Guidelines for Soliciting Life Insurance Rates & Terms from Multiple Sources such that such that A) client objectives are defined in advance (and thus all sources are providing information responsive to the request and not the "flavor of the day" life insurance product), B) the information provided is consistently presented (thus allowing for apples-to-apples analysis), and C) the steps of the process are coordinated for the benefit of the client (such that the actions of one respondent does not impair the ability of other respondents).
As Steve Morgan, CPA observes, "In today's life insurance marketplace, almost all products are a bundle of non guaranteed, undisclosed pricing assumptions. The client, either directly or indirectly, shoulders almost all the financial risks of the three product pricing components- mortality experience, carrier expense allocation, and investment performance. Consistent data gathering methods, and a sound financial evaluation process, are key to the integrity of any life insurance due care engagement. Independent advisors must ask the right questions. With the push and pull of the life insurance sales process, staying on track is critical to helping clients make the right life insurance purchase decisions. Following THEInsuranceAdvisor.COM guidelines gives the advisor another tool for getting to the right answers and unlocking the door to substantial life insurance savings."
Steve Morgan, CPA is the principal in a national practice based in Baltimore, MD. His firm provides accounting, taxation, funding analysis and related financial advisory services.
Suggested Guidelines for Soliciting Life Insurance Rates & Terms from Multiple Sources
The below are suggested guidelines for soliciting best-available rates & terms for various life insurance products from multiple sources such that client objectives are defined in advance (and thus all sources are providing information responsive to the request and not the life insurance product), the information provided is consistently presented (thus allowing for apples-to-apples analysis), and the steps of the process are coordinated for the benefit of the client (such that the actions of one respondent does not impair the ability of other respondents), as follows:
- Portfolio Objective: Define the target benefit objective (e.g., minimum-premium defined-death benefit of a specified amount, or defined-contribution of a specified amount for maximum accumulation, or some combination of the two). Also, where the target benefit objective is a defined-death benefit, then also define the planning purpose (if any) for portfolio cash values (e.g., Are cash values needed for a specific planning purpose like to repay a split-dollar receivable for instance, or to serve as collateral for a 3rd-party premium financing arrangement, or are cash values incidental to stated planning objectives and simply a function of the design by the insurer of a given product?). To the extent that cash values are not necessary to support the planning objective, then premium requirements can be lower for products that do not include cash values. For instance, because insurers must reserve for both the present value of expected future death claims as well as cash values redemptions, and because higher reserves mean higher premiums, then premiums can be lower for products that do not include cash values (e.g., term insurance products).
- Time Horizon: Define the needed duration of coverage (e.g., permanent coverage payable without regard to actual life expectancy, coverage to age 100, coverage to life expectancy, etc.).
- Funding Plan: Define the funding plan/premium budget (e.g., level-lifetime payments, limited-duration payments, single payment, etc.).
- Financial-Risk Tolerance: Define an acceptable level of default risk as measured by the insurer's ranking of aggregate financial strength and claims-paying ability ratings from all ratings agencies (e.g., Insurers must be ranked in the top-decile for financial strength and claims-paying ability.).
- Market-Risk Tolerance: Define an acceptable risk-tolerance for policy lapse and/or premium calls (e.g., fully-guaranteed, conservative, moderate-conservative, moderate, moderate-aggressive, or aggressive risk tolerance). If a recommended product is not fully-guaranteed, then request that the agent/broker calculate:
- the expected range of returns corresponding to the asset class for the risk tolerance to include the average annual rate of return and the highest and lowest expected returns calculated with a 95% degree of confidence (i.e., two standard deviations from the mean return).
- the probability of policy lapse and/or a premium call, and
- the expected earliest date of such policy lapse/premium call.
Such a range of returns is generally derived from statistical analysis of historical returns and historical volatility under the principles of Modern Portfolio Theory (MPT) and such policy lapse and/or a premium call calculations are generally derived using Monte Carlo Simulations. To the extent an agent/broker does not have MPT statistical analysis capabilities so as to calculate the expected range of returns and/or Monte Carlo Simulation capabilities to calculate the probability of policy lapse and/or a premium calls corresponding to either i) the volatility expected from a given allocation of invested assets underlying variable life policy cash values and/or ii) the undulation in interest rates expected from universal life products where cash values are required by regulation (as a practical matter) to be invested predominantly in high-grade corporate/government bonds and government-backed mortgages, then such calculations are available from Ethical Edge, LLC (see http://www.ethicaledge.biz/reports.html).
- Historical Performance Disclosures: While past performance is no guarantee of future results, historical performance is nonetheless one of the most common means for establishing the reasonableness of future expectations. As such, require all agents/brokers to confirm with the insurer of the recommended product(s) that
- cost of insurance charges (COIs) are based on actual mortality experience and do not reflect assumed mortality improvements, and if an insurer has changed COIs for inforce policies in the past, what was the nature of such changes to COIs (i.e., increases or decreases), the frequency/number of such changes, and the magnitude of such changes.
- policy expenses are based on actual operating experience and do not reflect assumed operating gains (e.g., "lapse supported pricing" in which assumed policy lapses are greater than the insurer's historical lapse ratio).
- assumed policy/dividend interest crediting/earnings rates are consistent with the historical return for invested assets underlying policy cash values. For instance, invested assets underlying universal life and whole life policy cash values are required by regulation as a practical matter to be invested predominantly in high-grade government and corporate bonds and/or government-backed mortgages for which the historical return is 5.5% - 6.0%, and thus the dividend interest crediting rate assumed in premium calculations for the recommended product should correlate with such historical returns. Similarly, invested assets underlying variable life policy cash values can be invested into an asset allocation consistent with the client's investor temperament, and as such, the policy earnings rate assumed in premium calculations for the recommended product should correlate with the historical returns for the asset classes corresponding to the recommended asset allocation of variable life policy cash values. In addition, require all agents/brokers to also disclose the actual historical performance of invested assets underlying policy cash values (e.g., the yield on the insurer's General Account for whole life and universal life products or the rate of return on the recommended mutual-fund-like separate accounts corresponding to the asset allocation appropriate to the client's investor temperament) for some meaningful period of time (e.g., 10 or 20 years) so as to be able to then relate this actual historical rate of return to the assumed policy/dividend interest crediting/earnings rate reflected in the proposal of the product warranted to provide best-available rates and terms.
While certain insurers may argue they have a reasonable basis for assumed mortality improvements, operating gains and/or investment performance that is greater than that for corresponding asset classes, any apples-to-apples comparison requires first that underlying assumptions are also apples-to-apples. To the extent an insurer has a rationale for assumed mortality improvements, assumed operating gains and/or assumed investment performance greater than that for the corresponding asset class, then that can be presented and evaluated separately.
- Cost Disclosures: Because premiums generally do not represent actual policy costs (e.g., just as a contribution to an Individual Retirement Accounts is not the "cost" of that IRA and instead the costs of both a life insurance policy and the IRA are equal to those deductions from premiums/contributions and/or policy/account values), require all agents/brokers to...
- disclose the insurer's representations as to year-by-year cost of insurance charges (COIs), fixed administration expenses (FAEs), cash-value-based "wrap fees" (e.g., M&Es) and premium loads (or for whole life products just the total of all these policy expenses in the aggregate). To the extent there are any additional fees not reflected in the insurer's illustration of hypothetical policy values (e.g., separate fees charged in fee-for-service type products), then any and all such additional fees must also be included and disclosed.
- calculate the time-value-of-money weighted-average annualized cost of insurance charge (COIs), fixed administration expense (FAE), cash-value-based "wrap fee" (e.g., M&E) and premium load (or for whole life products just the total of all these policy expenses in the aggregate) whereby in calculation of such weighted‑averages the policy expenses in the early policy years are weighted more heavily than such policy expenses in the later policy years using a time-value-of-money factor equal to the rate at which cash values would otherwise grow but for the deduction of such policy expenses. Also, to the extent that policy cash values are retained by the insurer upon death, and thus have the effect of reducing the net-at-risk amount of death benefit actually payable by the insurer, which in turn has the effect of reducing cost of insurance charges (COIs) during the life of the policy, then such cash values retained by the insurer upon death must also be included in the calculation of COIs by calculating the level annual payment that corresponds to a future value equal to the policy cash value at policy maturity (e.g., age 100 or age 120) and then adding that level annual payment to the time-value-of-money weighted-average annualized cost of insurance charge.
- if death benefits vary over time, then also calculate the present value of total costs per $1 of weighted-average annualized death benefits by again weighting death benefits in the early policy years more heavily than death benefits in the later policy years in calculation of the weighted-average death benefit using a time-value-of-money factor equal to the rate at which cash values and thus death benefits would otherwise grow but for the deduction of policy expenses.
The time-value-of-money factor to use in such present value, future value and weighted-average calculations would be the assumed policy interest crediting rate for universal life products, the assumed net-net policy earnings rate for variable life products (i.e., the policy earnings rate after deduction of both investment expenses like fund management expenses and cash-value-based insurance expenses like M&Es as discussed on page 43 of the March | April 2007 issue of the "Prudent Investor & TOLI" series/guide by ABA Trusts & Investments), or the dividend interest crediting rate for whole life products.
A general description of how to calculate the above can be found in the "$3 Trillion in Neglected Wealth" article published in May 2008 issue of Wealth Management Business magazine or in greater detail in U.S. Patent #6,456,979 on the U.S. Patent & Trademark Office web site. Also, because the Confidential Policy Evaluator (CPE) system produces research reports including all this information and more for any given product withOUT knowing the identity of either the client or the agent/broker, suggest/insist that CPE Research Reports be prepared for all product recommendations to quickly and easily perform all these calculations and ensure consistent calculations among all submissions.
- Published (Pre-Underwritten) Rates & Terms: In responding to #7 above, insist that all agents/brokers do not submit any medical information to any insurance companies for review by insurance company underwriters. Because different agents/brokers possess different negotiating capabilities and different relationships with the different underwriters, different underwriters can and do make different underwriting offers to different agents/brokers on the same case/risk. However, because insurance company underwriters make only a single rate offer in response to multiple requests, multiple submissions can result in the best underwriting offers being lost to the lowest/worst common denominator. Instead, instruct each agent/broker to provide
- their professional opinion as to the underwriting rate class for which they believe the applicant(s) will qualify, and
- their supporting rationale for such rate class(es). While such supporting rationale may not in-and-of-itself make sense to someone without medical/underwriting training, it will have meaning in relation to the supporting rationale from other agents/brokers, and insisting on supporting rationale reduces the chances an agent/broker might arbitrarily pick an aggressive rate-class without a reasonable expectation that such an aggressive rate-class is achievable. In the event an agent/broker cannot actually deliver on the "advertised" rate class in Section 9 below, then simply move on to the next-most-competitive agent/broker.
- Lead Underwriter Selection: The agent/broker who supplies the best rates and terms based on the above criteria will be selected as Lead Underwriter. Once an agent/broker is selected to negotiate underwritten rates and terms with a specified insurer, then also insist that rate offers be (at least initially) based on in-house retention only for that insurer only. In portfolios involving large face amounts and/or medical histories that present underwriting challenges, the best reinsurance rates can be lost to perceived redundancy if multiple primary insurers "shop the case" in the reinsurance market (e.g., if 3 primary insurers are underwriting $30M and all go to the reinsurance market, then the reinsurance market perceives this as a $90M case/risk because reinsurers have no way to control how much of what each reinsurer "approves" actually gets bound and thus they together "reserve" for a total of $90M in life insurance in my example here). Building a portfolio based on in-house retention only also preserves the ability to assemble a portfolio comprised of only internal capacity from multiple insurers (if advantageous) before going to reinsurance (e.g., if the best underwritten rates and terms are available from an insurer with a relatively low jumbo-participation limit like $10M, then that insurer would be precluded from participation in a $30M portfolio unless that insurer was "locked in" first. While this approach takes longer, securing best available rates and terms for larger portfolios and/or where there are challenging medical histories requires that holdings be sequentially assembled from ...
- primary insurers up to their retention limits,
- reinsurers up to auto-bind limits,
- more reinsurance up to jumbo-participation limits, and
- designating a "lead primary insurer" to negotiate any additional reinsurance on a facultative basis (where reinsurers actually underwrite also, if necessary).
If underwritten rates and terms do not come back consistent with original rates and terms representations, then simply move on to the next agent/broker who submitted the next-best published rates and terms. This sequential assembly of portfolio holdings prevents the reinsurance market from being "polluted" by an agent/broker that cannot deliver on original rates and terms representations and is all the more important in portfolios involving large face amounts and/or medical histories that are difficult to underwrite because of both recent contractions in the capacity of both primary and reinsurance markets and generally tighter underwriting guidelines by reinsurers.
*Our thanks go out to Steve Morgan for both taking the time to both review these new Suggested Guidelines for Soliciting Life Insurance Rates & Terms from Multiple Sources and for sharing is experienced perspective on life insurance product due diligence to help raise the standard or care for all advisors who touch life insurance in their practice. If you would like to know more about Steve's work, feel free to call him at 410-385-5673.