Recently, LIMRA’s 2012 Insurance Barometer Study took a look at consumer attitudes and behaviors concerning life insurance and financial services. According to the study, knowledge is one of the key factors in consumers’ decisions to purchase life insurance. While knowledge drives the purchase, lack of knowledge is a key barrier to not purchasing. In the LIMRA study, 45 percent of consumers said that understanding what is being bought and getting the proper amount of coverage were the first or second most important factors when purchasing life insurance.
Even more significantly, one-third of all consumers have delayed their decisions to purchase new or additional coverage because they didn’t know what or how much to buy, with 54 percent of those who believe they need additional coverage — a group one would assume had at least a basic understanding of life insurance — delaying their purchase for these reasons.
Fortunately, insurance professionals have a key advantage. Unlike some professions, most consumers consider life insurance agents knowledgeable, and more than half consider them trustworthy. And while direct purchasing has some acceptance with younger consumers, almost two-thirds of consumers still prefer to purchase life insurance in a face-to-face session with an experienced financial professional.
To take advantage of this opportunity, financial professionals need to have sufficient knowledge about various life insurance products. They must be able to help consumers determine which product is potentially the best match for their financial needs and then reassure consumers they are making intelligent decisions based on those needs.
The participating whole life product — and the guarantees it offers — should be on the short list for consideration when it comes to which life insurance policy many consumers should consider. This product can be ideal for both the early family formation years as well as the years spent in retirement. Participating whole life fits easily into the financial planning process by providing death benefit protection for the family along with accumulating cash value that can help to meet multiple financial needs during life.
The dividend advantage
Participating whole life products, in general, may have higher premiums than other life products, but one attractive feature is the possible payment of dividends, which could be used to reduce the premiums due on the policy. Dividends, if paid, are generated from three sources — investment earnings, mortality experience and expenses within the block of business.
- Investment earnings. Usually the largest piece of the dividend pie, these represent an average rate of return from the company’s general account portfolio.
- Mortality experience. This includes conservative design assumptions for the amount of annual death benefit claims that will be paid for the eligible whole life policies.
- Operating expenses. These include the cost of selling and maintaining the eligible whole life policies.
The annual dividend payout, if it occurs, may rise or fall depending on a company’s financial performance across these three areas. It’s important to note that customer expectations on the overall performance of a policy will be influenced by the interest rates that were projected in the policy’s illustration at the time the policy was sold. Using conservative interest rates and dividend assumptions will help to manage client expectations regarding the product’s performance over time.
When discussing the product, it’s important to understand the current low interest rate environment and its implications. These rates are reflected in many aspects of the life insurance business — including the dividend scales for whole life policies. During policy review discussions, clients often ask about the changing dividend rates for their policy. Having a bit of macroeconomic background information to share could prove to be extremely useful.
The low interest rate environment
Because investment earnings are a key driver in determining the dividend rate for a general account portfolio supporting a whole life policy and, ultimately, interest rates affect all insurance products, it’s important to understand the potential effects of prolonged low interest rates.
Overall, interest rates have been in decline for the past three decades. Since 2007, interest rates have sharply declined to historic lows. The low interest rate environment has had a notable impact on many segments of the economy, and the insurance industry is no exception. Low interest rates impact insurance companies’ investment earnings and, specifically, the performance of their general account portfolios.
The low interest rate environment is an industry-wide issue for insurance companies. This environment affects insurance company investments. More importantly, most life insurance companies’ use the portfolio method to determine the interest rate used in the dividend formula that has a direct effect on blocks of business. This method is based on the performance of a range of investments within a portfolio to accumulate to a desired return of equity that surpasses the invested amount. The portfolio yield is based on the average yield of all investments within it. As one block of investments matures, it’s replaced with a new block of investments that are contingent on current market yields. If the new block of investments has a lower yield than the block that matured, the total average portfolio yield may decrease.
So, as older investments with possibly higher interest rates mature in an insurance company’s general account portfolio, they may need to be reinvested into lower interest rate vehicles. Because investment earnings are one of the three areas from which dividends are determined and are, in fact, the most significant, the current low interest rate environment is negatively impacting potential product dividends.
Keep in mind that the current low interest rate environment is also affecting all “low-risk” categories of investments, too. Government bond portfolios, savings accounts, certificates of deposit, money market accounts, corporate bonds and Treasuries are feeling the same effect. So even in the current economic environment, participating whole life insurance products with guaranteed cash value accumulation and the potential for dividends may still be considered an attractive alternative.
If an insurance company’s dividend drops over time, policyholders who elected the accelerated payment option (AP), hoping their policies would require no more premium payments after a certain number of years, may be required to pay premiums for a few years beyond what was originally illustrated. That said, paying the extra premiums may be an attractive alternative to letting the policy lapse or replacing it. The guaranteed cash accumulation in a participating whole life policy may be considered attractive when compared to the returns of other low risk alternatives currently available in this economic environment.
A valuable product for clients and agents
Clients want to have the option to meet a number of financial needs, ranging from saving for a down payment on a house and accessing emergency funds to funding a college education or providing supplemental retirement income.1 Clients tend to want to be able to understand and, at the same time, simplify their financial portfolio, so they can better track and plan for the outcomes. Participating whole life may provide both the financial protection clients need to provide for their loved ones and multiple benefits built in to accumulate cash value in the policy.
While the primary reason for life insurance is the death benefit, there are certain advantages — or living benefits — included with participating whole life insurance policies. As I suggested earlier, participating whole life insurance should be on the short list of products you may want to present to clients. It’s a way to help meet their financial expectations for accumulating, protecting and ultimately transferring wealth to their loved ones while also providing a method of funding other financial needs during life.
The next time you have a policy review meeting or a prospecting meeting, you may want to discuss the attractive benefits of participating whole life insurance as a way to meet multiple client financial needs. It’s a good time to discuss its merits, which could add value to the relationship as you educate your clients and prospects about the life insurance options available to meet their financial needs — now and in the future.
- Distributions are generally treated first as tax-free recovery of basis and then as taxable income, assuming the policy is not a modified endowment contract (MEC). However, different rules apply in the first 15 policy years.
For more on whole life, see: