Why Would My life insurance policy
Underperform?
A life insurance policy is made up of many components.
These are the main factors that affect the performance of a
life insurance policy:
1. Interest/Dividend Rate credited – On traditional
(non-variable) Whole Life and Universal Life policies; the
dividends/interest credited are based on the overall
performance of an insurance company managed investment
account. Performance of the company’s investment
performance is unpredictable and can negatively as well as
positively affect your policy.
2. Expenses – these are the overhead costs - new business
costs, commissions, underwriting expenses, etc.
3. Declining Credit Rate Changes -- Twenty years ago, for
most life insurance companies, the interest crediting rate
was around 12% percent and currently the interest crediting
rate is approximately 4.5% to 5% which was the guaranteed
rate twenty years ago. Currently some companies pay a lower
interest rate and most have a lower guaranteed interest
rate than 4.5%. Most company’s credit at a higher rate than
their guarantee rate.
Example Of Declining Interest Rates On A Universal Life
Policy
A Universal Life policy was issued with a large, well rated
carrier on March 5, 1997 with a death benefit of $75,000.
The annual premium of $1,172 with the assumed interest rate
of 6.15% projected to endow (cash value = death benefit) at
his policy age 100. In projections run on April 5, 2004;
based on current assumptions, the policy will lapse
(terminate) at his policy age 91. To have the policy endow
(just 9 years later) at age 100, the annual premium would
need to be increased to $1,379 – an increase of 18%. Keep
in mind that the effects of a decreasing dividend scale on
a whole life policy will have a similar effect.
4. Cost of Insurance/Mortality Cost – Also known as the
risk charge. These costs increase annually based a table in
force on implementation of the new policy. This is the
amount applied for the pure cost of insurance.
Example of The Impact Of Increasing Mortality Costs
The most noted and common impact on the performance of a
life insurance policy is the interest rate as shown on the
example above. The larger and usually unknown/non-disclosed
impact is a change in the mortality costs. This impact is
usually unknown to the policyholder as well as the agent.
A change in mortality costs is much rarer than a change in
interest rates as far as anyone knows. A tick in the
interest rate has much less impact than an increase in the
mortality rates.
As an example, a policy owner with a large, well-known life
insurance company faces an extremely bad situation due not
only to decreasing interest rates as well as to increased
mortality costs. The company was not willing to admit to
the increased mortality costs; finally after a couple of
calls and letters, they admitted a .25% (or so) increase in
mortality costs.
Here’s the effect on this policy: The policy was purchased
on April 16, 1991 with a death benefit of $750,000 and an
annual premium of $5,661. The assumed interest rate at the
time was 8% (about average at the time). According to
inforce illustrations dated 2/26/2001 (current weighted
interest rate of 5.68%, the annual premium would need to be
increase to $11,137. On January 7, 1999, an inforce
illustration (weighted interest rate of 5.5%) showed an
increase to $10,711 in the annual premium. According to
inforce illustrations generated on May 12, 2005 (current
weighted interest rate- 5.16%); if he continues to pay the
annual premium of $5,661, the policy will lapse (terminate)
at his policy age 81. If he wishes to continue the policy
to his policy age 100, the premium would need to be
increased to $13,805 annually.