Life Insurance Policy Evaluation and Comparison Methods

Louis LopesWritten by Louis Lopes, CLU ChFC
Clifford PendellReviewed by Clifford Pendell

Choosing the right life insurance plan can be complex, especially when considering permanent cash-value policies like Whole Life, Universal Life, Indexed Universal Life, and Variable Life.

Each has unique features and benefits, making it crucial to compare similar policies and understand the detailed illustrations provided by insurers.

This article will guide you through reading and interpreting life insurance illustrations, helping you make an informed decision that fits your financial needs and goals.

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Choosing the Right Permanent Cash-Value Life Insurance Plan

Assume that you have decided that a permanent cash-value life insurance plan fits your needs. You have also narrowed down the type of life insurance plan you want: a traditional Whole Life or Universal Life, an Indexed Universal Life, or a Variable Life policy. It is now time to compare similar policies from the carriers and select a company.

You did your research and found that MassMutual or Guardian have the best Whole Life plans. Mutual of Omaha or John Hancock have the best Indexed Universal Life plans. But is that really the best plan for you at your age and the risk class? How do you evaluate proposals that are specific to you?

Comparing Term Life and Guaranteed Universal Life Policies

Comparing Term Life and Guaranteed Universal Life policies is straightforward. While other factors may come into play, the primary consideration is often which carrier offers the lower premium for the same coverage. However, comparing cash-value permanent policies is not so simple.

Understanding Life Insurance Illustrations

For permanent life insurance, pricing suitability depends upon a number of factors, and the lowest premium may not always offer the best value. When comparing permanent coverage, most buyers and agents pull out illustrations to compare columns of numbers.

The 1992 Society of Actuaries Report: Key Takeaways

Life insurance illustrations serve as a visual guide to a policy's potential outcomes over a specific period. They effectively demonstrate how a policy functions and how interest or investment performance can influence it. However, it's crucial to note that they are not a reliable tool for understanding cost competitiveness, performance reasonableness, or the policy's risk appropriateness. They are not a forecast of future values but rather a tool to aid in understanding the policy's mechanics.

In 1992, the Society of Actuaries published an examination of illustrations and illustration practices associated with the purchase of life insurance. Its conclusion “… when illustrations are used to show the client how the policy works; (it is) a valid purpose of the policy illustrations. Illustrations where typically used, however, to portray the numbers based on certain fixed assumptions – and/or are likely to used to compare one policy to another- are an improper use of the policy illustration.”

Furthermore, it went on to say, “How credible are any non-guaranteed numbers projected twenty years in the future, even if constructed with integrity? How does the consumer evaluate the credibility of two illustrations if they are from different companies? Or even if they are from the same company, if different products with different guarantees are being considered? Most illustration problems arise because the illustrations create the illusion that the insurance company knows what will happen in the future and that this knowledge has been used to create the illustration.” The use of illustration is especially egregious when comparing IUL products.

Key Components of Permanent Life Insurance Plans

How can one compare and choose the right policy, then? Start with the components of every permanent plan. The premiums of every life insurance policy are based on three factors:

  • Cost of Insurance (COI)
  • Policy Expenses (PE)
  • Interest/Earnings (I/E)

Below we've examined each component. The premiums are based on the formula COI + PE – I/E.

Cost of Insurance (COI): What You Need to Know

Cost of Insurance (COI) is a deduction from permanent life insurance policies to cover anticipated payments for death claims. COI reimburses the insurance company for the risk associated with paying the death benefit. Because the risk of death increases with age, so do COIs. It is like a premium for an annual renewable term policy.

For example, suppose a group consisted of 1,000 healthy 30-year-old males, and we want to provide $100,000 to the families of the members who died. If two members died, we would need $200,000. We would then need to collect $200 from each member for the $200,000 to pay the claims.

The COI Rate then is $2.00 per $1,000 for a 30-year-old. Suppose our group had consisted of 1,000 healthy 50-year-old males instead. We might have ten members die on average. To pay the $1,000,000 in claims for that year, we would need to collect $1,000 from each member. The COI Rate for the 50-year-old group would be $10.00 per $1,000.

Now, suppose that our group consisted of 99-year-old males. If nine hundred members died, we would need to collect $90,000 from each member to pay the $90,000,000 benefit to the families of those who had died and the COI Rate for the 99-year-old group is $900.00 per $1,000. For a $100,000 term plan, the amount at risk to the insurance company remains constant at $100,000.

For a permanent plan, the amount at risk to the insurance company is the difference between the cash value, which is already owned by the policyholder, and the death benefit. For a permanent plan with a death benefit of $100,000 and a cash value of $70,000, the insurance company is at risk for $30,000 should the insured die that year. The COI deducted from the policy would be the COI Rate (based on age that year) X $30,000.

Policy Expenses: Breaking Down the Costs

Policy Expenses consist of Fixed Administration Expenses, Premium Loads, and Cash-Value-Based Wrap Fees.

  • Fixed Administration Expenses are related to actuarial design, underwriting and new business processing, and service and administration and are calculated as some fixed amount set at the time of policy issue.

  • Premium Loads are calculated as a percentage of premiums paid in a given year and typically range from 0% to 35%. They cover state premium taxes, DAC taxes, and Sales Loads/Expenses.

  • Cash-Value-Based Wrap Fees are insurance fees charged as a percent of policy account values, similar to Fund Management Fees. The most common cash-value-based fee is the Mortality and Expense (M&E) charge intended to cover the risk that the actual cost of insurance charges and actual expense charges will be greater than expected. Fees typically range from 0% to 1% and may apply for a specific time or up to a specific dollar amount.

Interest and Earnings: Evaluating Investment Performance

The performance of any permanent life insurance policy depends on the number of cash-value investment options, their historical performance, and the cost-effectiveness of the various cash-value allocation options. The cash values of traditional whole life and universal life plans are invested in the insurer’s general account, which is managed by the insurer and required by regulation to invest predominantly in fixed-income securities like high-grade corporate bonds and government-backed mortgages.

Cash values in variable products are directed by the policyowner among a family of mutual-fund-like separate accounts offering a wide range of asset classes, typically including an assortment of domestic and foreign stock funds, and an array of domestic and foreign bond funds, a money market account, and usually a fixed account. To properly evaluate a permanent plan, the gross returns of investments must be evaluated along with the investment expenses incurred, resulting in the net policy rate of return.

Veralytic Reports: An Independent Evaluation Tool

Evaluating all these factors, the Cost of Insurance, Policy Expenses, and Investment/Earnings performance, is a daunting task for the most sophisticated investors and even more so for the typical insurance buyer. No wonder insurance buyers revert to comparing illustrations. What is needed is an independent third party that can evaluate all the factors to evaluate a proposal.

Veralytic is such a third party. It will take a proposal and evaluate policy by comparing the components of the policy, the COI, PE, and I/E against industry benchmarks. Benchmarks are quite common in the financial services industry. For example, when evaluating a mutual fund selection, the performance of that mutual fund is compared to a standard point, an independent point of reference, such as the S&P 500.

Veralytic Reports use actuarially determined representative costs and performance levels for products of a specified product type for comparison purposes. Veralytic Benchmarks are used to compare the pricing and performance of a given life insurance product to determine the appropriateness of a given life insurance policy selection. The report will then evaluate and rate a policy based on five criteria:

  • Insurer Financial Strength
  • Cost Competitiveness
  • Pricing Stability
  • Policy Liquidity
  • Historical Performance

Additional Analysis for IUL and VUL Policies

If you are purchasing an Indexed Universal Life (IUL) or Variable Universal Life (VUL) plan, you still have some work to do. Whole Life and Universal Life returns vary over time, but they don’t have the volatility that IUL and VUL plans have. The typical IUL or VUL illustration shows the same rate of return every year for 30, 40, 50, and 60 years.

Using Monte Carlo Simulations for Accurate Projections

However, the return on the IUL or VUL might be 0% one year and 10% the next. This exposes them to the Sequence of Return Risk, even if the illustration assumes a conservative average rate. The proposed policy must be evaluated to determine the probability of success.

We can use a Monte Carlo simulation tool that tests how the policy will perform with a thousand randomized returns with the same average return and standard deviation. Life Insurance Sustainability Analytics (LISA) is a tool that tests the illustration, providing a real-world assessment of the probability of lapse, allowing you to make modifications for better outcomes.

Using Lisa, one study of a typical illustration found that a shocking 50% of policies will lapse before age 100, even if the long-term average return is correct. Typically, a premium increase of 35% was needed to make the sequence of risk a nonfactor.

Mind you, even if the agent is conservative and runs the illustration at a lower interest rate that the agent believes is more realistic, the policy will have a significant probability of failing. The issue is not the long-term rate of return. The risk is pure due to the sequence of return risk.

Conducting a Thorough Analysis: The Importance of Due Diligence

With the staggering range of options, deciding on the ideal life insurance plan requires careful consideration of your unique financial situation, goals, and risk tolerance. Analyzing takes time, and the reports cost money.

If you are investing tens or even hundreds of thousands of dollars in a policy, you owe it to yourself to do the due diligence. Working with an experienced agent can help you navigate the complex landscape, saving you time and money.

How JRC Insurance Group Can Help

JRC is an independent life insurance agency that represents 63 highly rated providers. Having access to dozens of insurers and their underwriting guidelines allows our agents to anonymously shop the market on your behalf to match you with the best policy for your budget and needs.

We're licensed in all 50 states and our agency offers at least a decade of life insurance experience. More importantly, our consultative shopping services are completely free. Connect with us today at 855-247-9555, or select your state from the map below to instantly compare permanent life insurance rates from dozens of providers.

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Written by:

Louis Lopes

Louis Lopes, CLU ChFC

Chartered Life Underwriter, Licensed Life and Health Agent

Louis has been in the insurance business for over 30 years. He specializes in “high risk” cases as well as more complex coverages for long term care, disability, and estate planning.

Expert reviewed by:

Clifford Pendell

Clifford Pendell

Managing Partner and Co-founder

Cliff is a licensed life insurance agent and one of the owners of JRC Insurance Group. He has helped thousands of families of businesses with their life insurance needs since 2012 and specializes with applicants who are less than perfect health. In his spare time he enjoys spending time with family, traveling, and the great outdoors.

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