Failing Policies - What Causes This? Part 3 of 3

By Kellan Goldberg, Managing Director, Insurance Decisions on Wednesday, December 3rd, 2014


Many clients recognize the benefits of using life insurance as an investment, but they can be sold on this premise with optimistic assumptions - which are often at odds with reality.

  1. Cash values will increase every year with optimistic market performance.

  2. Eventually premiums can be discontinued and investment performance will maintain the policy.

Those assumptions are made primarily when dealing in variable policies, but universal life and indexed universal life policies are also subject to this kind of rose-colored thinking.

The first thing an RIA should do is dispel unwarranted optimism the client may have heard elsewhere.

This is not a reflection on anyone’s intentions, but there is no way to predict where the market is going to be, or what interest rates are going to do. The best anyone can do is offer a ballpark figure, but using conservative numbers. Illustrations can only assume a constant rate of return on a variable policy - but even with a conservative course of action aiming for a 5% return every year, for all intents and purposes there is no chance that person will realize a 5% return, every single year, for many years. So clients should be made aware of the need to monitor these policies, just as they do their investment portfolios.

Another erroneous assumption insurance agents often make, especially with variable policies, is relying too heavily on historical data.

Typically, any 20- or 40-year S&P 500 historical will show average rates of return at 8% or higher. Such overly optimistic or misleading projections are part of the reason there are so many policies falling apart today. During the heydays of variable policies, from the 1990s to the early 2000s, they were being projected to have 12-14% rates of return. These unsustainable, high rates of return were the result of the market outperforming during that time period. Now many of those policies are “underwater.”

Instead of relying on historical data, policies should be closely monitored and managed. When the market is down, people should be paying above their premiums in order to compensate. If a policy is not monitored on an annual basis, or at least every other year, the policyholder is not going to realize that they have missed these marks until they’ve past the point of no return and are underwater.

Another popular investment-based product in the insurance industry are index policies. Index policies typically feature a cap and a floor. For example, a policyholder may get a 0% floor, which means that he or she cannot be credited anything less than 0 - so it essentially protects from down markets. However, it does not guarantee a client will never lose money. There are still fees and expenses being drawn from the policy, and during down markets, cash values can decline.

Once again, assuming historical data for these contracts is unfair. Many illustrations show what a policy would have been credited over the past 20 years based on the market’s return. However, it is unlikely that the caps on the policies would have stayed constant at today’s rates. We have already seen caps fluctuate over the past four years, to assume that a 12% cap today would have been realistic during every market cycle of the last 20 years is unrealistic.

That is the reason it is so vital that RIAs look at their clients’ policies every year. If the client puts more money into the policy when the market is down, when it does rally, those increased payments will make up for it.

It is important that an RIA’s client knows how important it is to not be overly optimistic with their assumptions, or everything built on that assumption risks falling apart.

Kellan Finley is managing director of Insurance Decisions, a leading insurance resource for independent financial advisors. Working exclusively with independent advisors, her primary focus is to help advisors better understand the value of insurance within a financial plan. She provides expert guidance in the areas of Life Insurance, Disability Insurance, Long Term Care, and Annuities.



You might also be interested in:

Failing Policies - What Causes This? Part 1 of 3 [Blog Post]
Failing Policies - What Causes This? Part 2 of 3 [Blog Post]
Having the Healthcare Planning Conversation [White paper]

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