Life Insurance Illustrations: Friend or Foe?

You must give careful consideration to how you use illustrations in your presentations.

By Glenn Stevick

Advisors making life insurance presentations typically rely on policy illustrations to show the client how a life insurance policy works. The illustrations are a tool designed to help the advisor explain an intangible and complex financial product. They display key policy guaranteed values and hypothetical nonguaranteed 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 cost of policies from different insurers. Illustrations do not create accurate projections of future performance for comparison purposes because of the differences in assumptions between insurers and the problems 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 advisor does not clearly explain the differences, 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. A full explanation of the illustration is especially important when focusing on the projected cash values, dividends or interest accumulations. Lower credited interest rates or dividends, and increases in administrative expense or mortality charges can all negatively affect the illustrated cash values.

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 nonguaranteed assumptions is that what is projected will not happen. We must assume that illustrations will never be a totally accurate prediction of future policy performance.

Insurance regulators have placed emphasis on proper illustration formats and a clear distinction of what is guaranteed in the contract as a result of the Life Insurance Illustrations Model Regulation that the National Association of Insurance Commissioners adopted. This regulation provides rules to protect consumers and foster consumer education. Its goals are to ensure that policy illustrations do not mislead purchasers of life insurance and to make illustrations more 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 consequences. Although this regulation has established minimal guidelines, insurers are still free to make their own assumptions. Therefore illustrations are of limited value for comparing policies from the same or different insurers.

The “best” product
Policy illustrations are terrible tools for finding the “best” product. They do not show what a client will get, but rather what he would get if all the company’s assumptions about the future came true, which is nearly impossible. How will mortality, interest rates and expense factors change over the next 20, 30 or 40 years? None of these factors can be predicted with certainty. These projections can be especially problematic when the cash value accumulation is based on variable interest rates or the value of underlying investments, or where alternative premium payment arrangements are being proposed.

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 from actual internal rates of return. The use of lapse-supported pricing assumptions, nonguaranteed persistency bonuses and “pie-in-the-sky” mortality or expense improvements can lead to unrealistic illustrations.

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. There must be an understanding of what assumptions are made regarding mortality, persistency, expenses and interest to truly compare illustrations.

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 its record of meeting policy projections. What is the financial strength of the company? How well has it met its projections in the past? This approach can lead to realistic consumer expectations and help avoid disappointment in the future.

Glenn Stevick is an LUTC author and editor with The American College and a member of Tri-County AIFA (Pa.). Contact him at Glenn.Stevick@TheAmericanCollege.edu.