In today’s environment, a careful and independent review of in-force policies is critical to ensure your policy will meet your original projections and provide the coverage your clients expect. An independent review that includes these six steps can pinpoint the most critical policy issues and identify the best possible solutions:
1.Review the policy’s crediting rate: Not all changes in cost are as obvious as a hefty increase in your cost-of-insurance (COI) charge. While most product illustrations include a constant crediting rate, even a small change in that rate can significantly impact the actual performance of your policy. For instance, if the rate was originally at 5%, but the policy is now delivering 4%, especially over a prolonged period of time, you can expect a shorter duration of death benefit coverage, higher premiums to maintain coverage or less retirement cash flow. It’s also important to note that dividend interest rates for whole life policies are not guaranteed—though many are presented that way. Carriers have the freedom to reduce dividend interest rates and raise charges within the dividend.
2. Review the carrier’s financial strength. The rating of an insurance company’s financial soundness is often used as a key differentiator when choosing a policy. But the strength of any business can change. Market downturns can damage company earnings, investment portfolios and capital reserves. Moreover, the ratings are not always easy to interpret. The big three rating agencies, Fitch, Moody’s and Standard & Poor’s, each have their own ratings systems, making comparing various carrier ratings as troublesome as comparing bonds. That said, it’s important to balance the carrier rating with expected policy performance. An analogy is that “Aaa” and “Baa” bond ratings at Moody’s both qualify as investment grade, but as long as the bonds do not default, the “Baa” bond will provide over 100 basis points more yield than the “Aaa” bond. The same type of balancing act applies to insurance companies, where you sometimes need to make a trade-off between carrier financial strength and product performance. Also, while life insurance carrier insolvencies are rare, it is always important to review the carrier’s financial strength annually to make sure clients get the death benefits they depend on.
3.Review product charges that impact performance. These charges include a percentage of the premium to cover the costs of issuing and administering the policy and the cost of insurance, primarily to cover death claims. While product charges are subject to guaranteed maximums, it used to be rare for insurance companies to make changes to charges, whether they were increases or decreases. But as we’ve explained, the low-interest-rate environment means that’s no longer the case. Charges can vary by as much as 80% for different products. A careful review will reveal what is being charged for COI, as well as fixed administration expenses (FAEs), cash-value-based “wrap fees” and premium loads.
4.Stress-test policies with downside scenarios. Stress testing is used to analyze the myriad factors that can cause a policy’s “illustrated” performance to change. A thorough stress test includes building out illustrations to analyze how lower crediting rates may affect the policy—including the revised cash values by year and at maturity. Stress testing can also help identify strategies for protecting the value of the policy. These may include increasing premiums or reducing the face amount of the policy.
5.Assess the client’s ability to fund the policy. The success of any policy is based on the policyholder’s ability to pay the premiums. If funding drops below the original calculations, even for a relatively brief period—something that was all too common during the recent financial crisis—the policy performance and coverage period will be negatively impacted. In a worst-case scenario, the policy can lapse completely—a scenario that is more likely than ever in the face of doubled or tripled premiums.
6. Perform a detailed product comparison. Despite the interest rate environment, many competitive life insurance products remain available. Some carriers are particularly skilled at proactively managing portfolio yield distribution—a key factor in successfully managing crediting rates and helping to keep in-force policies intact. Other carriers are adept at offering products specifically tailored for the ultra-affluent. Other attributes to consider are the long-term claims-paying ability of the insurance company and the company’s track record in terms of pricing and guaranteed minimum credit ratings.
All carriers are suffering the effects of the “perfect storm.” No one is immune. That’s why an independent policy review is imperative to ensure your client’s policy delivers the expected income and death benefit. Even if interest rates start to rise, it will take time to compensate for the damage that’s already been done to carriers’ bottom lines. In the wake of this changing economic environment, it is vital to proactively manage your life insurance to maximize policy performance and protect your ability to achieve your client’s financial goals.
David Buckwald, CFP, CLU, ChFC, CLTC, NSSA, and Jeffrey D. Dattolo, CFP, CLU, ChFC, CLTC, AEP, NSSA, are partners of Atlas Advisory Group LLC, an independent planning firm based in Cranford, N.J., and a member firm of M Financial Group.