It’s no secret that life insurance policies include an immense level of complexity. For many reasons, these products can be difficult to understand, and even more challenging to explain effectively to clients.

When LIMRA recently provided a life insurance IQ test to 4,000 Americans to gauge their knowledge and understanding of life insurance, a stunning 70% failed the test. And it’s no wonder. Even with the help of policy illustrations, significant case design expertise is often needed to make sense of intricate policy details—especially when it comes to the internal costs and fees within each policy.

For financial advisors, it’s critical to not only understand how fees can impact performance, but also to be able to educate clients on how various fees can impact policy suitability over the long-term.

While minimizing costs is always desirable, when it comes to life insurance, every fee has the power to reduce the policyholder’s death benefit coverage, making comparing cost structures vital. Unfortunately, even the best illustrations can often make two policies seem equal on the surface, which is precisely why security regulators prohibit using illustrations to determine product suitability. However, when costs and fees are analyzed in detail, one product may be a far better fit for the specific client.

Here are some basic facts to help decipher some of the most common policy expenses and how they may impact long-term policy suitability:

Cash-Value-Based Fees: Potentially the most significant of these expenses are Cash-Value-Based Fees—policy-specific charges calculated as a percent of current policy account values. Included are Mortality & Expense Risk charges in variable policies that provide insurance companies an interest spread to cover expenses and profit. Products with high Cash-Value-Based Fees are typically not suitable for clients purchasing insurance to accumulate tax-deferred cash values and retirement income.

Cost of Insurance Charges (COIs): An often mysterious charge, this fee covers the actual costs of paying death claims, and can account for as much as 85% of total policy expenses. Because some insurers “load” COIs to cover expenses not disclosed elsewhere, the charge can be highly unpredictable and may vary significantly among otherwise similar policies. Products with high COI charges are not efficient options for clients purchasing insurance for lowest cost (i.e. premium) and with less emphasis on cash value growth.

Fixed Administration Expenses (FAEs): More predictable than Cash-Value-Based Fees and COIs, Fixed Administration Expenses (e.g. $7.50/month or $5.00 per $1,000 of death benefit) cover the costs of actuarial design, underwriting, new business processing, and policy service and administration. FAE costs are typically minor compared to other costs, but they can be difficult to overcome for low-cost funding designs such as lowest premium for stated death benefit.

Premium Loads: Designed to cover state premium taxes, federal deferred acquisition costs, taxes, and policy distribution costs, premium loads are calculated as an annual percentage of premiums paid and can range from 0% to as high as 35% or more. Products with high premium loads are not suitable for clients who are seeking significant cash-value growth from policy inception.

Even with a basic understanding of these terms, it can be difficult to accurately compare policies because insurers are far from consistent with how they define fees. But there is good news: because case design is improving every day, there really isn’t a “bad” insurance product on the market. However, not every product is right for every client.

This makes it more important than ever to dive into the detailed cost and fee structure for each policy and perform a comprehensive analysis of product suitability for the individual policyholder.

Products have different strengths and weaknesses. While one product is designed to provide cash-value growth, another is built to offer the lowest possible premium.

Some products provide a balance of lower cost and strong cash-value growth. Cash-Value-Based products tend to be sensitive to both upside and downside changes in crediting rates (or, for variable products, earned rates), while low-cost products tend to be less sensitive to these changes.

Detailed analysis—rather than a basic running of illustrations—of different premium funding patterns and interest-rate scenarios can help quantify product strengths and weaknesses in order to determine the most suitable product based on each client’s objectives and risk/reward appetite.

Whether advisors have a case design specialist in house or leverage outside guidance, understanding how these policy fees can impact long-term performance—and clearly communicating the cost/benefit to clients—can not only improve product suitability, but can also help protect benefits and deliver greater value for every client.

Jeffrey D. Dattolo, CFP, CLU, ChFC, CLTC is a Partner and Director of Advanced Design at Atlas Advisory Group LLC, an independent planning firm based in Cranford, NJ. A Member Firm of M Financial Group, Atlas Advisory Group LLC specializes in investment tax planning and wealth transfer for executives. Independently owned and operated, Atlas Advisory Group LLC is registered with M Holdings Securities, a Registered Broker/Dealer and investment advisor (RIA). Member FINRA/SIPC.