POLICY PRICING CALCULATOR DEFINITIONS
Following are the definitions for the three premium pricing components (defined below):
Premiums = COI + E - i%
• Claims paid for death benefits, or Cost of Insurance (COI)
• Expenses associated with policy design and administration (E)
• Investment earnings (i%)
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COST OF INSURANCE:
Payments for claims are referred to as the Cost of Insurance or COI. For most kinds of insurance, paid claims are the largest single cost factor. With life insurance, COI charges can account for 75% - 80% or more of the total premium.
To make claims more predictable, insurance carriers pool policies. (According to the "Law of Large Numbers," the larger the pool, the more predictable the risk.) Pooling, which combines low and high risk segments of the pool, averages the COI charges that contribute to premium prices.
While pooling helps carriers manage their risks, averaging impacts pricing values for different members of the pool. That is, averaging cross-subsidizes higher-risk segments with excess "profits" from the lower-risk segments of the pool. Consequently, products priced for pools of individual buyers may not represent the best value for lower-risk segments of the pool.
Since different pools of policy holders have different claims experience, premiums will vary depending on the claims experience for the pool being insured. Historically, pools of individual policy holders have the highest claims experience while select pools of professionals, business executives and owners, and high net worth individuals have superior claims experience.
Generally speaking, because professionals, business executives and owners, and high net worth individuals enjoy healthier lifestyles and better health care, they live longer. Products priced for this market generally have lower COI charges than products priced for other groups.
Most buyers only have access to insurance priced for pools of individual buyers (what we refer to as "retail pricing"). While most products will continue to be priced to serve this largest segment of the market, a growing number of buyers are gaining access to experience-rated pricing.
Expenses:
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Expenses or "loads" are charges for the design, sale, service, and administration of insurance policies. These charges include state premium taxes, federal DAC taxes, underwriting expenses, carrier overhead for actuarial service and product development, and sales and service fees.
These expenses are charged to policy holders as a percent of the premium (premium-based loads), as a fixed charge (fixed expense), or as a percent of the value of the policy (asset-based loads). In addition, products for pools of individuals may also impose onerous back-end charges for surrendering the policy during the initial 10 to 15 years.
Large public companies purchase insurance differently than the average "retail" buyer. Because these large transactions and large groups of policies cost less to sell and administer, carriers typically reduce institutional premiums to reflect volume discounts and economies of scale.
Because institutional and experience-rated products are maintained longer, are more well-funded, and are larger, they have lower expense ratios than products for pools of individual buyers. In addition, institutional and experience-rated products assess more reasonable charges or no charge for early surrender.
Policy Earnings:
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All permanent life insurance policies are credited with interest and/or investment earnings after COI charges and expenses (Es) have been deducted. While life insurance policy projections can use a wide range of interest and investment earnings assumptions in calculating hypothetical policy values, actual policy performance will ultimately be a function of the actual performance of invested assets underlying policy cash values. As such, the Policy Pricing Calculator will produce the most accurate results when the selected assumed policy earnings rate is based on actual historical investment performance for the asset classes appropriate to the product type, investment temperament of the policyowner, policy holding period, etc., as described below.
Universal Life & Whole Life Policies
Universal Life (UL) and Whole Life (WL) policies are credited with a declared interest rate, much like Certificates of Deposit (CDs) offered by banks. UL products fully disclose this net interest amount credited to policy cash values, net of deductions for investment expenses and management fees. On the other hand, WL products include this interest inside the policy "dividend", and do not disclose the amount of interest, and neither UL nor WL policies disclose investment expenses and management fees. Assets underlying both UL and WL cash values are also required by regulation to be invested in high-grade corporate bonds and government-backed mortgages, the historical rate of return for which has averaged almost 6.0% over the long-term (Source: http://www.ibbotson.com/). As such, the Policy Pricing Calculator will produce the most reasonable approximation for UL and WL premiums and costs when using an Average Net Rate of Return most closely correlates with the historical return for the asset classes into which cash values are required to be invested (i.e., 6.0% +/-). On the other hand, to compare the pricing of a particular policy to TIA Benchmark premiums and costs, use an Average Net Rate of Return equal to that of the policy you are comparing.
Variable Life & Variable Universal Life Policies
On the other hand, variable life and variable universal life policies earn a rate of return that is directly related to the performance of invested assets underlying policy cash values (instead of the declared rate in UL and WL policies that is indirectly based over time on the performance invested assets underlying policy cash values) and are required to fully disclose all policy expenses, including investment expenses and management fees. Variable policy cash values can also be directed into a family of mutual-fund-like "separate accounts", typically including an assortment of domestic and foreign stock funds, an array of domestic and foreign bond funds, a money market account, and usually a fixed account (i.e., similar to an account into which UL and WL policy cash values are invested).
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