Certainly, almost every industry deals with the same thing but the idea of saving a buck on insurance is an entrenched ideal. Independent agents who can bring multiple offerings from various insurance carriers are exceedingly valuable but only if they understand what theyâ€™re doing and arenâ€™t playing the spreadsheet game.
Penny wise and pound foolish is an age old axiom but just because itâ€™s been around for a long time doesnâ€™t mean lessons are learned.Â
Letâ€™s look at a 50-year-old preferred male and a â€śname brandâ€ť $1 million indexed universal life policy, the product du jour for better or worse. I had it run three ways at the default crediting rate of 6.09 percent and the premiums are $7,842, $8,115 and $11,360. Remember, if this insured died tomorrow or next year or 20 years from now, the beneficiaries will get the same $1 million. In fact, each of the three scenarios is projected (not guaranteed) to last to age 100.Â Most people would ask, why pay more than the $7,842? Isnâ€™t anything else just a waste?
Letâ€™s dig in a little. The low premium gets the policy to age 100 with minimal cash value and wonâ€™t last beyond then. The middle premium projects to fund a policy that will have $1 million of cash value at age 100 and last beyond and the high price one is â€śoverfunded.â€ť
Costs of Insurance
To start, weâ€™ll focus on the two cheaper options. The premium difference is only $273 or about 3.5 percent of the premium. Thatâ€™s not much but if I only get the $1 million death benefit and not the death benefit and the cash value, why do I care about the cash value growing? Well, thatâ€™s a deep discussion for another day but Iâ€™ll tell you that should careâ€¦ a lot!Â Have you heard ofÂ costs of insurance (COIs)? Thereâ€™s a lot of chatter about this in the market today because some carriers are increasing them to make their nickel, even when the mortality experience isnâ€™t getting worse. This is exceedingly important, and you should be reading about it. However, COIs play a big role in contracts even when you arenâ€™t getting stiffed.
The COI is based on the spread between your death benefit and your cash value. This is referred to as the amount at risk. The lower your clientâ€™s cash value, the greater the spread and the more dollars his COI is being applied to. Remember, your clientâ€™s â€śper dollarâ€ť COI stays the same at a given age regardless of the spread but the gross COI is greater because itâ€™s being calculated on more dollars. This isnâ€™t really much different from why a $2 million life insurance policy costs more than a $1 million policy but you wouldnâ€™t try to buy a $2 policy by paying the $1 million policy premium, would you? Thatâ€™s not going to end well. Even though the mortality charge rate is the same, the gross expense is different. When your client is young, this isnâ€™t a huge issue because the COIs are very low. However, when your client is Â 80, 90 or 100 years old, the COIs matter a lot.Â
As your client gets older, does he want to be paying COI on a big spread or a little spread? If your client paid $7,842, his spread at age 90 is $622,000 and if you paid $8,115 your spread is $520,000. Not huge, but why pay for an extra $100,000 of insurance at the rate the company charges a 90 year old for life insurance if you donâ€™t have to? At age 95 it is $629,000 and $340,000 respectively. At age 99 it is $808,000 and $79,000 respectively. At age 100 it is $987,000 and $0. You can imagine the cost of insuring the chances of death for a 99 year old, canâ€™t you?
When running these projections, if I click the box in the illustration software to include the expense pages and isolate only the mortality charges, the cumulative expense from age 50-100 goes down from $968,000 when paying $7,842 to $319,000 when paying $8,115. Thatâ€™s a 67 percent decrease. When trying to support a $1 million policy with about $400,000 of cumulative premium, does your client really want an additional $650,000 of expenses being yanked out of the contract? When I look at the mortality costs from only age 90 to 100, the expense goes from $678,000 to $62,000. Thatâ€™s a 91 percent drop. Does your client really want to save 3.5 percent in premium only to pay a 1,000 percent increase in mortality charges if he outlives actuarial life expectancy?
Now, hereâ€™s where the rubber meets the road. If your client manages to not buy the farm before age 100 (and more and more people are making it), the 3.5 percent greater premium keeps the contract in force indefinitely with no more out of pocket. Saving $273 a year means at age 101, your client will have to start paying $291,000 every single year until he dies or the policy will beat him to the grave. You read that right. When they bring in the cake with 100 candles, theyâ€™ll also bring in a premium notice for $291,000â€¦ every year your client sticks aroundâ€¦ for a $1 million policy. Are you willing to assume that risk?
So itâ€™s not really about the $273 year, itâ€™s about dramatically reducing the expenses in your clientâ€™s contract, which will result in a much higher cash value with the bonus of a nice refund if your client ever chooses to bail on the contract and not have to pump in more than 1,000 times that much per year to keep the thing breathing if he gets lucky. By the way, the internal rate of return on that $273 to reduce your clientâ€™s mortality expenses by hundred of thousands of dollars and not risk paying even more hundreds of thousands of dollars in premiums is pretty astounding.Â
All this being said, if you really understood what was going on, statistically neither of these premiums are likely to fund a policy that will last anywhere near where the ledgers propose they will.Â What youâ€™re looking at is all hypothetical, and it wonâ€™t pan out as projected, guaranteed. This is where the â€śridiculously highâ€ť $11,360 premium comes in.Â
Just maybe the higher premium may be in your clientâ€™s best interest even in a death benefit focused transaction? Stay tuned. Weâ€™ll touch on this next time.
Bill Boersma is a CLU, AEP and LIC.Â More information can be found at www.oc-lic.com, www.BillBoersmaOnLifeInsurance.info, www.XpertLifeInsAdvice.com or email [emailÂ protected]