Life Insurance Illustration Assumptions…a Trustee’s Dilemma

In the early ‘80s when interest rates skyrocketed (Are you old enough to remember 18% mortgCaptureage rates?) the insurance industry created Universal Life insurance (UL), with sales illustrations based on “current assumptions,” which included the fixed rate being credited to the policy’s cash value at the time of the policy’s issue. As with all sales illustrations, the historically high “current” assumptions were projected over the life of the insured, creating a rosy scenario that was easy to sell. The higher the interest rate credited, the lower the premium needed to sustain the policy. Unfortunately, as can be seen by the chart to the right, which shows the actual crediting rate of a top UL carrier, those rates did not hold. The rosy scenario promised turned into a thorny reality as policy cash values plummeted and policies lapsed. In the mid to late ‘90s when a monkey with darts could rack up double-digit returns in the equity markets, many agents were selling Variable Life contracts tied to the equity markets with 12% annual return assumptions. How did that work out? Same outcome: crashing cash values and lapsing policies. Even venerable old Whole Life has seen a steady downturn in dividend rates over the last twenty years, with forecasted “vanishing premium” scenarios that led to vanishing policies and lawsuits. Point being, a sales illustration is just a projection, and your job as a trustee is to determine whether that projection will come true.

This brings us to the industry’s current hot product, Indexed Universal Life (IUL), which accounted for half of all UL sales in the first quarter of 2015. In a past blog post, “What You (as Trustee) Need to Know about Equity Indexed Universal Life,” I wrote about this product. Briefly, its cash value is driven by the returns in an index, typically the S&P 500, but the reason it is touted as “conservative” by sales agents is that it has a floor in the returns, typically 0%, so it “cannot lose money,” like a Variable policy. That is true, but for a Trust Owned Life Insurance (TOLI) trustee, the real question, as with the preceding policy types, is: will the premium and the rate of return actually earned on the cash value allow this policy to run to maturity or at least to life expectancy? We at ITM|21st have seen hypothetical illustrated returns of 8% and up used on sales illustrations, which we believe are unreasonable. A past blog entry, “Illustrating Equity Index Universal Life Policies,” spoke to the issue and highlighted a carrier-created website where you can input the hypothetical long-term equity return, and the website will translate that to the actual credited rate you will receive in a policy. Assuming the typical 100% participation rate, 10% cap, and 0% floor, a 12% return in the index used would equate a 6.75% crediting rate applied to the policy. Granted, the carrier points out that this is but “one approach” to determining an outcome and not a “predictor,” but it provides us with some guidance to develop more realistic illustration assumptions.

Unfortunately, there are some in the industry who do not sell these policies with realistic assumptions, so the National Association of Insurance Commissioners (NAIC) is readying new rules that appear to limit the hypothetical returns shown in IUL sales illustrations to the 6% to 7% range. These new rules are expected to be phased in September 1, and we will be following up with information at that time. Until then, if you are a trustee, we still suggest: if you are taking in an IUL policy with a crediting assumption of 7% or higher, get a second illustration with an outcome of 5% as the basis for policy funding. If by chance the policy is actually credited with a 7% return over time, your client can possibly lower the premiums in later years. It is better to have a client with expectations that can be exceeded than a client whose expectations will undoubtedly be dashed.