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Preparing clients for bad news about insurance products

Additional downgrades to future interest earnings expectations would seem likely, particularly given the current low-interest-rate environment.

Last month, we discussed how many insurers in the U.S. are announcing broad cost increases and giving guidance downgrading future interest earnings expectations. We also discussed how financial advisers too often get it wrong by using comparisons of hypothetical values for the in-force policy versus some sales proposal/illustration of some new product when discussing life insurance with clients.
In response to these increasingly frequent announcements of cost increases and declining future interest expectations, how can financial advisers can get it right when discussing life insurance with clients?
Take, for example, an insurer that downgraded future interest earnings expectations from 7%+ to a little less than 7%. Should clients expect more downgrades? And what is the dividend interest crediting rate that is reasonable to expect? Advisers who follow a prudent process answer these questions using proven and established principles like those found in the West Point Draft of Best Practice Standards for Life Insurance Stewardship.
Best practice standards prescribe an acronym for ascertaining the interest crediting rate that is reasonable to expect: RATE (the Risk profile of the client, the corresponding Asset class preferences, the planning Time horizon, and the performance that is reasonable to Expect). The asset classes into which cash values of whole life policies are required by regulation as a practical matter to invest are high-grade bonds and government-backed mortgages.
While past performance is no guarantee of future results, the historical rate of return from high-grade bonds and government-backed mortgages averaged about 5% in round numbers since the 1920s. However, just like most other financial products, some product managers outperform others, and this insurer has a track record of out-performing the averages by approximately 75 bps over the past five years.
ADDITIONAL DOWNGRADES
As such, additional downgrades to future interest earnings expectations would seem likely, particularly given the current low-interest-rate environment. Future downgrades would also be consistent with the historical correlation between the dividend interest crediting rate for this insurer steadily declining from a high of 12%+ in 1985 to 6%+ for next year, and the similarly steady decline in yields on high-grade government and corporate bonds from 12%+ in 1985 to 2%-4% today.
However, interest rates seem to be generally bottoming and may soon be on the rise. So could it be that dividend interest crediting rates also are bottoming? Probably not due to the lag caused by longer-term bonds and mortgages underlying whole life policy cash values, which result in lagging higher returns while prevailing rates are declining, but then also lagging lower returns when reinvesting as prevailing low(er) rates rise, as was seen in the 1980s.
This lag effect also makes future interest earnings expectations on whole life products inherently incongruent with such forward guidance for other product types, and is another reason why comparing illustrations of hypothetical policy performance is considered “misleading,” “fundamentally inappropriate,” and unreliable by financial, insurance and banking industry authorities. So instead of comparing illustrations, think about and talk about life insurance like you do with other assets.
More announcements of cost increases and declining performance expectations are almost certainly coming. Grow your business by helping clients understand how to respond to these changes in ways they already understand.
Next month I’ll discuss how to talk with clients about cost increases.
Barry D. Flagg is the founder of Veralytic Inc., an online publisher of life insurance pricing and performance research and product suitability ratings. Follow him on Twitter @BarryDFlagg.