Issues of Interest to
Advisors Today
Presented by Wayne E Thomas, CLU®
Member Agent, The Nautilus Group
A service of New York Life Insurance Company
May 23, 2012
Disclaimer
This seminar is for informational purposes only. Neither New York Life Insurance Company
(NYLIC) nor its employees or agents are in the business of providing tax, legal or
accounting advice, and none is intended nor should be inferred from the foregoing
comments and observations. Everyone should be advised to seek the counsel of their own
tax, accounting and legal advisors who must form their own independent opinions on these
matters based upon their independent knowledge and research.
Wayne E. Thomas, CLU® is an Agent of New York Life Insurance Company.
Wayne E. Thomas, CLU® is a Member Agent of the Nautilus Group, a service of New York
Life Insurance Company.
The “Hidden” Assumptions
“Once the policy is in force,
I won’t have to look at it again.”
• Life insurance – can’t get it and forget it
– Long-term
– Requires ongoing evaluation
• Advisor may be asked for advice in managing
• the life insurance results
– Doesn’t have to be an expert.
– Does have to know what to look for and where
the problems areas lie.
The “Hidden” Assumptions
“Get along with the grantor
and all is well.”
• Trustee may think working for grantor but accountable
to beneficiary
“Interest rates will stay the same.”
• Most policies placed more than 5-10 years ago designed to
benefit from higher interest rate.
• No action now, may require higher premiums later.
– Will money be available?
– Will gifting be available to transfer funds to trust?
Longevity is the Key Word
• When buying policy - longevity of the:
– Insured
– Policy
– Life insurance provider
• Responsible advisor must synchronize duration of
insured, policy and provider
– Looked at individually
– Coordinated together
– Assessed on a regular basis
• How long does policy need to last?
Longevity of a Person
• Starting point – life expectancy
– Expected number of years of life remaining at given
age based upon average
• Actual number of years remaining varies widely
• Selecting the right policy – not insured’s life expectancy,
but how long insured might live.
Chances that a 65-year-old will live…
Advisor Checklist
• Questions about the Insured
– Do you know the insured’s life expectancy?
– Do you know what the chances are of the insured
living beyond his/her life expectancy?
– Have you reviewed how long the policy is projected
to stay in force?
– If the policy ends, would your client qualify for new
coverage?
Longevity of a Policy
• Life insurance intended to be in force at death
• Policy purchased based on assumptions in force at
that time
• In real life, circumstances change, which may alter
expected results
• Advisor should continually measure performance
by actual results
Frequently Asked Questions
About a Policy
• How accurate are illustrations?
– Illustrations based on assumptions
– Actual experience may be different than illustrated
projections
• What would cause the policy to terminate before
your client dies?
– Type of policy
– Assumptions used
• What assumptions were made for the policy?
Product Basics
• Term Life
• Whole Life
• Universal Life
Pricing Basics
• Financial models built to develop and price
products
• Need to make assumptions about the future
• Each product group has distinct assumptions and
drivers of profitability
Why Would Term Insurance End?
• Policy designed to end after term of years
• Premiums not affordable
• Premiums not paid
Why Might a Whole Life Insurance
Policy End?
• Premiums not paid
– Whole life policies have non-forfeiture options
– Default option varies by company
• Reduced paid-up policy – reduced face amount
• Extended term policy – same face amount for a
period of years
• Loans taken, interest due not paid, interest and
loans exceed available cash value*
* The cash value in a life insurance policy is accessed through policy loans, which accrue
interest at the current rate, and withdrawals. Loans and withdrawals will decrease the cash
surrender value and death benefit.
Key Drivers of UL Pricing
• Product design
– Determination of policy charges
• Policyholder behavior
– Premium funding pattern
– Lapse/surrender/loan
• Mortality
– Proper underwriting
– Reinsurance
• Interest crediting strategy
– Portfolio vs. new money
– Spread
Key Drivers of UL Pricing - continued
• Reserves
– UL reserve requirements
– Financing solutions
• Cash Surrender Value
• Expenses and Taxes
• Required Capital
– Company ratings matter
– Higher rated companies = more supporting capital
• Producer Compensation
Post Pricing Hurdles
• Filing & State approval process
• Illustration certification
– Illustrated scales must qualify as disciplined current
scales (DCS)
– Must break-even within certain period
– Cannot be overly reliant upon surrenders
– Prevents bait & switch
• Non-guaranteed Elements (NGE) testing
– Must declare method for changing in advance
– Must demonstrate profitability is higher/lower than
declared before NGE can be changed
Why Might a Universal Life Insurance
Policy End?
• Two types of coverage
– Guaranteed UL*
– Non-guaranteed UL
• Non-guaranteed UL
– 3 elements
• Premiums
• Crediting Rate
• Mortality charges
– Policy no longer has enough cash value to pay
monthly insurance charges.
* All guarantees are subject to the claims paying ability of the issuing company
Why Might a Universal Life Insurance
Policy End?
• Most policies originally
designed to endure, but
something changes:
– Less premium paid
– Lower crediting rate than
expected
– Higher expenses than
expected
Premium
$
Paid
$
$
% Rate
Credited
$
$
$
Monthly
Expenses
Advisor Checklist
• Questions about the Policy
– When was the last time the life policy was
reviewed?
– At current levels of interest, charges, and premium
payments, how long will your client’s policy stay in
force?
– Have any premium payments been late, reduced, or
missed?
– Have any loans or cash withdrawals been taken?
Advisor Checklist
• Questions about the Policy – continued
– For term insurance policies
• Will the policy remain affordable as long as you
need it?
• Are there conversion privileges to a competitive
permanent product?
– Is your client’s policy subject to dramatic market
fluctuations?
Advisor Checklist
• Questions about the Policy – continued
– Will the death benefit be jeopardized or lost if cash
is withdrawn or borrowed?
– What guarantees are there that the policy will be
around when the beneficiaries need it the most?
– Is the policy subject to dramatic market
fluctuations?
Longevity of a Life Insurance Provider
Promise
to be there in
future
Premiums
Insurance provider
must be
Strong and
Solvent
• Why are ratings
important?
• What if insurance
provider’s rating are
downgraded?
Advisor Checklist
• Questions about the Insurance Provider
– Has the financial strength of the insurance company
changed?
– What is the current insurance provider’s
rating/financial outlook?
– Does the insurance provider have an adequate
surplus of assets?
– What is the investment policy for the provider’s
general account assets?
Life Insurance Financial Strength Ratings
• If you do estate planning or individual income tax
planning you have probably been asked to evaluate
life insurance policies
– Compare specific policies of different companies
– Find best coverage for the money
• But, the financial strength of the carrier may be
equally important
– Need to know that the company will be able to pay
off future claims
Overview
•
•
•
•
•
•
Why is financial strength a critical issue?
Current rating systems
Validity of the ratings
Company presentation of the ratings
How the ratings are determined
What happens when a company fails
Importance of Financial Strength
• More important for an insurance company than for
other companies because of the very long-term
obligations
– For a 50-year-old insured, claims may be paid up to
40 to 50 years in the future
– Should deal with a company having a conservative
long-term perspective
Possibility of Financial Impairment
• Rare for large companies with a long history
• Risk is much greater for smaller companies
– At least 69 insurance companies taken over by state insurance
departments since 1983*
– In today’s environment, even some large companies not run
properly (but with midpoint ratings) could experience financial
impairment
– Current recession might make financial impairment more
common in the future
*National Organization of Life and Health Guarantee Associations (NOHLGA) Website, Facts &
Figures, Impairments & Insolvencies
Possibility of Financial Impairment
• Current recession might make financial impairment
more common in the future
• National Organization of Life and Health Guarantee
Associations (NOHLGA) Website, Facts & Figures,
Impairments & Insolvencies
• A.M. Best Special Report, July 19, 2010, 19762009 Impairment Review.
Rating Agencies
• Four main life insurance company ratings agencies:
– Moody’s
– Fitch
– Standard & Poor’s
– A.M. Best
• Moody’s, Fitch and Standard & Poor’s are
sometimes referred to as the “Big 3” Ratings
Agencies
– Better known for their bond ratings
– Also rate sovereign debt
• A.M. Best is the oldest and rates only insurance
companies
Rating Scales
• The rating scales are very different
• The following slides show the scales for the four
main rating agencies and an explanation of what
the ratings mean
• The ratings are sometimes divided into two
categories—secure and insecure
• The secure ratings on the first chart are shown in
green and the insecure ratings in red
Rating Scales
Rank
A.M. Best
Standard & Poor’s
Moody’s
Fitch
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
A++
A+
A
AB++
B+
B
BC++
C+
C
CD
E
F
AAA
AA+
AA
AAA+
A
ABBB+
BBB
BBBBB+
BB
BBB+
B
BCCC+
CCC
CCCCC
R
Aaa
Aa1
Aa2
Aa3
A1
A2
A3
Baa1
Baa2
Baa3
Ba1
Ba2
Ba3
B1
B2
B3
Caa1
Caa2
Caa3
Ca
C
AAA
AA+
AA
AAA+
A
ABBB+
BBB
BBBBB+
BB
BBB+
B
BCCC+
CCC
CCCCC
C
Meaning of the Ratings
AM Best
S&P
Moody’s
Fitch
A++ and A+: Superior ability to
meet ongoing insurance obligations
AAA: Extremely strong capacity to Aaa: Exceptional financial security.
meet financial commitments. Highest While the financial strength of these
rating.
companies is likely to change, such
changes as can be visualized our
most unlikely to impair their
fundamentally strong position.
AAA: Exceptionally strong capacity
to meet policyholder and contract
obligations. This capacity is highly
unlikely to be adversely affected by
foreseeable events.
A and A-: Excellent ability to meet
ongoing insurance obligations
AA: Very strong capacity to meet
financial commitments.
Aa: Excellent financial security.
Together with the Aaa group, they
constitute what are generally known
as high-grade companies. They are
rated lower than the Aaa companies
because long-term risks appear
somewhat larger.
AA: Very strong capacity to meet
policyholder and contract
obligations. This capacity is not
significantly vulnerable to
foreseeable events.
B++ and B+: Good ability to meet
ongoing insurance obligations
A: Strong capacity to meet financial
commitments, but somewhat
susceptible to adverse economic
conditions and changes in circumstances.
A: Good financial security.
However, elements may be present
which suggest a susceptibility to
impairment sometime in the near
future
A: Strong capacity to meet
policyholder and contract
obligations. This capacity may
nonetheless, be more vulnerable to
changes in circumstances or in
economic conditions.
(See pages 16-17 of the Special Section in Resource Guide for complete chart.)
Comdex Ratings
• Composite score for ratings of Moody’s, Fitch,
Standard & Poor’s and A.M. Best
• A company must have ratings from at least two of
the rating agencies to receive a Comdex score
– Companies rated on a scale of 1 to 100 in relation
to other companies
– The numbers reflect percentiles
– A score of 90, for example, would mean the
company scored higher than 90% of all companies
rated
• In this environment, recommend only buying from
companies with the highest possible Comdex score
How Good are the Ratings?
• Criticisms
– Conflict of interest because most rating agencies
are paid by the companies they rate
• Percentage of ratings paid for by insurance
companies:
– Moody’s………………………………100%
– A.M. Best…………………………….100%
– S&P…………………………………….82%
– Fitch……………………………………44%
– Too slow to spot negative trends and revise ratings
• Particularly troubling is their recent failure to spot
problems with mortgage backed securities.
How Good are the Ratings?
• Evidence
– 2003 Federal Reserve study
• Rating agencies more concerned with guarding
reputation than pleasing clients
• Only minor distortions in ratings
• Ratings ordinarily reliable
A.M. Best Study - Conclusions
• Conclusions
– Ratings correlate strongly with future financial
impairment
– Significant difference even between A++/A+ and
A/A- ratings
– Suggests that although a AA rating or 90 Comdex
score is considered very good, an A++ rating or 95100 Comdex score might be significantly better over
a long period of time
– Percentages increase rapidly over time
• What would they be after 30 or 40 years?
• Extremely important given the long-term nature
of policy obligations
Company Presentation of Ratings
• Insurance companies and/or agents could
selectively present ratings in their marketing
materials
• These ratings can be difficult to assess for several
reasons
– The scales are not directly comparable
– Companies present their ratings in the most
favorable manner possible
– Ratings tend to minimize differences between the
higher rating categories
Differences in the Rating Scales
• A given letter might mean something quite different
in one scale than in another
– B is “fair” for A.M. Best, but “weak” for Fitch
– A+ is “superior” for A.M. Best, but only “strong” for
Fitch and S&P
• A letter might have a higher rank in one system
than in another
– For A.M. Best, A+ is the second highest rating
– For Fitch or S&P, A+ is only the fifth highest rating
Differences in the Rating Scales
• The rating systems have different numbers of
categories
– Fitch, Moody’s and S&P all have 21, while A.M.
Best has only 15
– A given rank on the A.M. Best scale may not be
comparable to the same rank on one of the other
scales
Favorable Presentation
• A company with ratings at or near the top from
every rating agency would simply present all of the
ratings
• Companies with somewhat lower ratings might
present only their better ratings, perhaps making
the company look better than it really is
Caution—What the Ratings Do Not Show
• The ratings reflect expectations that a company will
be able to make good on its future policy
commitments.
• They are not an evaluation of:
– Any specific insurance product
– Whether a company’s products provide good value
for the money
– Whether specific policy provisions are desirable
How are the Ratings Determined?
• The rating agencies have somewhat different
methodologies, but the method used by A.M. Best,
summarized below, is typical
– Four factors considered:
• Balance sheet strength
• Recent operating performance (profitability)
• Business profile
• Information from meetings with management
team on a company’s prospects
Balance Sheet Strength
• Three general factors—
– Capitalization
– Adequacy of loss reserves, asset valuation reserve
(AVR) and surplus
– Quality, diversification and liquidity of assets
Capital Adequacy
• Moody’s provides the following chart showing
capital as a % of total assets for various ratings*
–
–
–
–
–
Aaa…………………….>12%
Aa……………………….8%- 12%
A…………………………6%- 8%
Baa……………………..4%- 6%
Ba………………………< 4%
*Moody’s Global Rating Methodology for Life Insurers, 2006
Quality of Assets
• Moody’s provides the following chart showing the
percentage of high risk assets held by companies
with various ratings*
–
–
–
–
–
Aaa…………………….<10%
Aa………………………10% - 20%
A…………………………20% - 30%
Baa……………………..30% - 40%
Ba………………………>40%
*Moody’s Global Rating Methodology for Life Insurers, 2006
Diversification
• Investment portfolio diversification
– Spreading investment funds among a variety of
assets and asset classes to:
• Minimize risk for any given level of expected
return, or
• Maximize expected return for any given level of
risk
• Product and business line diversification
– Diversify by insurance product and region
– Possible diversification into related businesses like
capital management
• Highly rated companies are well diversified in both
ways and have efficient investment portfolios
Liquidity
• Ability to meet policy obligations without selling
long-term assets.
• Most important measure is liquid assets as a
percentage of policyholder reserves.
• Other measures:
– Quick liquidity ratio
• Liquid assets/total liabilities
– Current liquidity ratio
• Total current assets/total liabilities
Liquidity, Cont’d
• Moody’s provides the following chart showing liquid
assets as % of policyholder reserves for various
rating categories*
–
–
–
–
–
Aaa…………………….>80%
Aa………………………60% - 80%
A…………………………40% - 60%
Baa……………………..20% - 40%
Ba………………………<20%
* Moody’s Global Rating Methodology for Life Insurers, 2006
Profitability
• Profitability is an important part of a company’s
ability to meet policy obligations
• Basic measure = return on equity (ROE)
• ROE = Net income/shareholder’s equity
• For a stock company both earnings and capital
appreciation are important
• For a mutual company, earnings and surplus are
the key indicators
Profitability
• Moody’s provides the following chart showing ROE
for various rating categories*
–
–
–
–
–
Aaa…………………….>15%
Aa………………………10%-15%
A…………………………5%-10%
Baa……………………..0%-5%
Ba………………………<0%
* Moody’s Global Rating Methodology for Life Insurers, 2006
What Happens to a Company with
Financial Difficulties
• The company can be taken over by state regulators
– They will first try to sell policies to another company
• Even if they are successful, owner may lose
coverage or end up paying higher premiums
• If insured dies while regulators have policy, there
may be a long delay in paying off the policy.
– If the policies can’t be sold, the failed insurance
company is generally liquidated.
• All 50 states have life insurance guarantee
associations that protect policyholders of failed
companies from shortfalls in the liquidation
proceeds.
Companies with Financial Difficulties continued
• Unfortunately, the benefit cap in most states for an
individual life insurance policy is only $300,000.
– Given that the recommended life insurance
coverage for a median-income family is about
$500,000, many policyholders would not be fully
compensated if covered under a single policy.
• NOHLGA reported that from 1991 through 2008,
state guarantee associations covered only about
82% of all life insurance liabilities.
• The benefit cap for cash surrender or withdrawal
value is even lower, at $100,000.
Mutual vs. Stock Companies
• Easier for a mutual company to maintain high asset
quality and long-term focus
• Stock companies generally must produce shortterm returns to keep stockholders happy
– Potential pressure to make riskier investments that
favor stockholders over policy holders and may not
be in the best long-term interests of the company
• A mutual company has no stock, so the interests of
the policy holders are better aligned with the longterm interests of the company
Who should I buy from?
• Why focus on the company? Why not just
comparison shop and buy the cheapest option?
• Questions to ask
• For Current Assumption UL, Non-Guaranteed
Element (NGE)
–
(Non- Guaranteed Element) can change
– For Guaranteed UL, there are no NGEs to changehow do you know the company will be there in 30
years?
– For WL, what is the history of paying dividends?
• In the end, the client is buying a promise
Next Steps
Talk to your agent.
Annually review the policy.
Adapt or change policy to realign with
your beneficiaries.
Determine if policy meets beneficiaries’ objectives &
trustee’s fiduciary responsibilities.
Research & analyze the policy.
Review questions regarding the insurer.
Thank you!