Life insurance presentations typically rely on policy illustrations to show the client how a life insurance policy works. They are a tool designed to help the advisor explain an intangible and complex financial product. They display key policy guaranteed values and hypothetical non-guaranteed values based on performance assumptions involving interest rates, mortality, and expense charges.
Policy illustrations work well to educate clients on how policies work, but they are not an adequate tool for comparing the costs of different policies. Illustrations do not create accurate projections of future performance for comparison purposes because of the differences in assumptions between insurers and the problem of estimating future performance of the company and the economy.
Clients do not always understand the differences between guaranteed and illustrative (hypothetical or current) values and the assumptions underlying illustrations. If the differences are not clearly explained, a prospective client can easily be misled into believing that the policy promises significantly greater values than those contractually guaranteed. Allowing this misconception to exist, or actually fostering it, is a serious form of misrepresentation.
Assumptions and fantasies
Policy illustrations are based on assumptions that project what may happen based on past, current, and future performance. The chance that all of these factors will interact consistently as proposed is virtually impossible. The only thing we can guarantee about an illustration under the non-guaranteed assumptions is that what is projected will not happen.
Insurance regulators have emphasized proper illustration formats and a clear distinction of what is guaranteed in the contract as a result of the Life Insurance Illustrations Model Regulation adopted by the National Association of Insurance Commissioners (NAIC). This regulation provides rules to protect consumers and foster consumer education. Its goals are to ensure that policy illustrations do not mislead life insurance purchasers and that illustrations are understandable by clearly defining what is and is not guaranteed in the contract.
Prior to this regulation, there were no uniform standards. Information within a single report varied drastically from one insurer to another. Rogue insurance companies could publish illustrations with any assumptions they wished without regulatory consequence. Although this regulation has served to establish minimal guidelines, insurers are still free to make their own assumptions. Therefore, illustrations are of limited value for comparing policies.
The "best" product
Policy illustrations are terrible tools for finding the "best" product. Policy illustrations do not show what a client will get, but rather what he or she would get if all the company's assumptions about the future came true, which is nearly impossible.
Consumers and advisors are naturally drawn to illustrations that show the highest cash values, lowest premiums, or fewest years of premium payments. Yet any advisor who understands the time value of money realizes that very small differences in interest rates or expense loading can have dramatic effects over long periods. Average rates of return can be drastically different than actual internal rates of return. The use of lapse-supported pricing assumptions, non-guaranteed persistency bonuses, and "pie-in-the-sky" mortality or expense improvements can lead to unrealistic illustrations.
Some companies make conservative assumptions to minimize the chance that they will not meet expectations. Other companies are more aggressive to make their product look more attractive. The company with the "best" illustration may simply be the one that has the most optimistic assumptions about the future, not necessarily the one that will actually meet these expectations or deliver the most value to the client.
Do not fall into the illustration trap. Some illustrations may be illusions. Do your due diligence. Scrutinize the underlying assumptions of the policy and how it was created. Investigate the history of the company and their record of meeting policy projections. What is the financial strength of the company? How well have they met their projections in the past? This approach can lead to realistic consumer expectations and help avoid disappointment in the future.
Glenn E. Stevick Jr. is an assistant professor of insurance at The American College and LUTC author-editor, writing course materials for the LUTC program. Prior to joining the college in 2001, he served as an agent and training supervisor for 17 years for the New York Life Insurance Company. For more information, Mr. Stevick can be contacted at 610-526-1392 or glenn.stevick@theamerican college.edu.
