We’ll spare you the fluffy intro and cut to the chase.
- Explains whole life insurance policy illustrations.
- Advises you on how to make biased projections useful.
- Quickly describes the difference between term life rate projections and whole life illustrations.
Life Insurance Illustrations: An Overview
A policy, or sales, illustration is an educational tool that shows prospective policyholders how a life insurance policy works over time.
Illustrations show items such as premiums, cash values, death benefits, surrender values, and other, similar policy metrics.
Some of the figures in the illustration are guaranteed, while others are projections that may depend on the future performance of the company or the stock market.
Policy illustrations contain some figures that are guaranteed. The insurance company will honor these figures regardless of the policy’s future financial experience.
What is guaranteed depends on the policy type:
- Whole life insurance: guarantees premiums, cash value, and death benefit
- Universal life insurance: guarantees a minimum interest credit on the cash value
- Variable universal life insurance: guarantees the death benefit
In all cases, the company guarantees maximums for expenses and mortality charges.
The policy’s performance projections are based on the insurance company’s assumptions about future performance many years into the future.
Like any other assumption, actual results will be more or less favorable, and the longer the time period being projected, the greater the likelihood of variance from the predicted values.
The policy pricing factors that contain elements of uncertainty again depend on the type of policy:
- Whole life insurance: future dividend rates, which can vary based on the performance of the company’s investment portfolio
- Universal life insurance: the interest credited to the policy’s cash value
- Variable universal life insurance: performance of the pool of sub-accounts
In all cases, the company’s future expenses and mortality charges are also non-guaranteed.
Term Vs. Permanent Illustrations
For term life insurance, the policy illustration shows three things:
- Current and maximum premiums for each year
- Total premiums paid up to that year
- Each year’s death benefit
If there are multiple scenarios possible, the illustration will show the premiums in each scenario. (Policies that require an annual medical exam often have scenarios: a “high premium” case and a “low premium” case, depending on the results of the exam.)
Permanent Life Insurance Illustrations
Permanent life illustrations are significantly more complex.
Worse, they can be highly unreliable.
Why is this the case? Permanent life insurance policies have a cash value component, which grows based on market interest rates and the investment abilities of the insurance company.
These rates and returns are very difficult to project.
Interest rates have been as low as 0% during the 2008 financial crisis and as high as 20% during the 1970s. Investment returns, on the other hand, can be -100% at the low end (meaning, all of the company’s investments went to $0) and have no cap on the end.
So apart from the premiums, which are fixed, the other two projections for each year (the cash value and the death benefit) are not much better than guesses once you go past the first few years.
The issue is that many insurance agents don’t make this know to their customers. Instead, they use optimistic, highly unrealistic projections as a sales tool to win your business (and earn a commission).
Four Tips On Using Illustrations Wisely
So how can you be sure to make a good decision when buying a life insurance policy? Here are four actionable steps you can take.
1. Know Your Interest Rate
The most important part is to ask what rates have been used in the projection.
Interest rates and investment returns can fluctuate dramatically, for reasons completely outside of a company’s control.
Even if your agent assures you that they have used current, “actual” rates, there is no guarantee that these will stay the same in the future.
2. Compare Apples To Apples
Second, when comparing policies from different companies, make sure you’re looking at an apples-to-apples comparison.
Meaning, make sure your agent uses the same interest rate, term, and options for each life insurance illustration, across carriers and policy types.
3. Ask For A "Downside" Scenario
When comparing illustrations, you should always ask for two sets of projections. One that shows the projections at current interest rates and a second, “downside” scenario that shows the projections if rates drop by 2%.
You may be shocked by how much the numbers differ…
This is especially important to ask for when comparing policies from two different insurers.
In general, go with the company whose policy looks better in the downside scenario. This is likely to be the more conservative company, and therefore, the one more likely to meet their projections!
4. Have A Goal And Stick To It
Finally, make sure you know in advance what your goal is and stick to that.
You’ll be presented with a LOT of numbers. A single illustration could be 10+ pages, containing 1,000+ numbers. If you don’t know what your priorities are, this can make your head swim.
If your goal is to maximize the death benefit in the final year, just look at that figure for each policy and ignore the rest. If, instead, your goal is maximum cash accumulation, focus on nothing but the final-year surrender values for each policy.
An illustration involves three variables: the premium, cash surrender value and death benefits. The insurer's software will compute one variable based on selected assumptions for the other two. Illustrations must contain at least the guaranteed and current/nonguaranteed rates.
A policy or sales illustration is not a binding contract and does not guarantee how much a policy will be worth in any given year, except where values are explicitly stated as "guaranteed." The illustration is largely an educated guess determined by a computer program based on the available information at the time th
The purpose of this regulation is to provide rules for life insurance policy illustrations that will protect consumers and foster consumer education.
So don’t let these intimidate you. Life insurance illustrations are simply report cards, showing you how your life insurance policy will perform in future years.
While these “report cards” can help you make better, more informed decisions, if you don’t know how to use them well, agents can use these illustrations and the confusion they cause to sway you to a more expensive or more risky policy.
But just stick with the four-point plan above, and we’re confident that you’ll leave with a policy that puts your family in a better, safer place.
If you have any questions, don’t hesitate to leave a comment or send us an email!
The GetSure Team