Last year, many life insurers issued forward guidance for continued downgrades to policy earnings expectations. When declining policy earnings cannot cover internal policy costs, then clients must either pay more premium to get expected benefits or settle for less than expected. The old way of responding to such performance downgrades has been to compare an illustration of hypothetical policy values for the inforce policy to another hypothetical projection for some new and usually different product type in an effort to find a product with higher earnings expectations.
This old way of responding to declining policy earnings expectations typically exposed the client to additional — although usually undisclosed — risks that rarely solved the problem and too often only exacerbated the problem. For instance, in Cochran v. Keybank, Mr. Cochran started with more than $4 million of mostly universal life in the 1980s, but then exchanged to variable universal life in response to declining interest expectations during the 1990s, and then exchanged again to guaranteed universal life again in response to declining earnings expectations in the 2000s, ending up with only half the death benefit he started with — hardly a solution to declining policy earnings expectations.
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More recently, many life insurers also started announcing cost increases. Such costs increases make policy under-funding problems even worse where declining earnings expectations are already insufficient to cover internal policy costs even before the cost increases. Such cost increases also beckon a new way of thinking about and talking about life insurance that changes the focus away from hypothetical premiums and cash values based on some assumed earnings expectation, and instead redirects attention toward the most significant driver of long-term policy performance and client satisfaction — low costs, and most importantly low cost of insurance (COI) charges.
COI charges typically comprise 85% of total policy costs, and can vary by as much as 80% between best-available rates and terms (BART) and worst-available rates and terms (WART). Such a wide variance between good BART pricing and bad WART pricing often means there's an equally large opportunity to bring clients and prospects tangible value in the form of clearly quantifiable cost savings. And with as many as 10,000 pricing combinations and permutations for the various age-cells, gender, risk class, tobacco use, volume break-points, funding strategy, etc. in each product, there are many more opportunities to solve under-funding problems by examining and reducing costs than by comparing hypothetical illustrations looking for a product advertising a higher earnings expectation.
After all, even if some illustration suggests a higher earnings expectation, comparing illustrations rarely, if ever, reveals the additional risk inherent in higher earnings expectations. This is among the reasons why such industry practices are now considered “misleading,” “fundamentally inappropriate,” and unreliable by financial, insurance and banking industry authorities. And even when higher earnings expectations may seem reasonable and consistent with the client's risk profile, options in response to future earnings downgrades are limited. Earnings expectations for all insurers generally move in unison correlated with performance expectations for the asset classes of invested assets underlying policy cash values, which would be the same for all products appropriate to a given risk profile.
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A new year is a time for new things. So I say out with the old comparisons of hypothetical policy values and in with a new way of prudently selecting and properly managing life insurance that focuses on minimizing cost of insurance charges. In the past, under-performance had largely been attributed to declining earnings expectations. Now, insurers are increasing costs with increasing regularity. Talking with clients and prospects about life insurance policy costs and cost increases in the right way can solve under-performance problems caused by both performance downgrades and cost increases, and in-so-doing earn new clients and generate new business.
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.
