How To Determine The Right Policy

Areas of analysis

Selection of the proper type of product

Deciphering life insurance policy illustrations

Reviewing policy comparison measurements

Studying company comparison measurements
Chapter 4
Tools & Techniques of Life
Insurance Planning
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How To Determine The Right Policy Chapter 4
Tools & Techniques of Life
Insurance Planning

Selection of the proper type of product

Personal preferences
 “Own” versus “renting” insurance

Cash accumulation versus buy term and invest the difference

Rules of thumb

Buy term

If risk taking propensity is high

If client has a lease versus own preference

Buy permanent
 If client has an “own rather than loan” preference

If client wants something to show for the money

Buy a blend
 if client is somewhere in between these two preferences
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How To Determine The Right Policy Chapter 4
Tools & Techniques of Life
Insurance Planning

Amount of insurance needed

Rules of thumb

Buy term when there is no way to satisfy the death need without it

Buy a combination of term and permanent insurance

Client can cover the entire death need, and

Able and willing to allocate additional dollars to appropriate permanent coverage
 Cash flow considerations

Multiple premium cash flow combinations (examples)

Pre-pay coverage as fast as possible

Limited payments over a regular interval

Pay premiums over a lifetime
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How To Determine The Right Policy Chapter 4
Tools & Techniques of Life
Insurance Planning

Cash flow considerations (cont'd)

Rules of Thumb

Prepay coverage if the client expects to live longer than average

Pay on an installment basis if the client expects to face a greater than average mortality risk

Purchase YRT if the client wants to pay the absolutely minimum premiums

But is willing to pay increasingly larger premiums each and every year
 Duration of need considerations

Needs less than 10 years – Term

Needs 10 to 15 years – Term and/or permanent coverage
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How To Determine The Right Policy Chapter 4
Tools & Techniques of Life
Insurance Planning

Duration of need considerations (cont'd)

Needs 15 years or more – Permanent coverage
 Needs to cover buy-sell agreement – permanent coverage

Needs to cover estate taxes – permanent coverage
 How to decipher policy illustrations

Identify the columns

Premiums, cash values, death benefits

Policy dividends
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How To Determine The Right Policy Chapter 4
Tools & Techniques of Life
Insurance Planning

How to decipher policy illustrations (cont'd )

Critical questions to ask

What does the client pay versus what the client gets if the client lives and the beneficiaries receive if the client dies?

What portion of those amounts are guaranteed and what portion of those amounts are not?

What interest or other assumptions are built into these figures?

Emphasis on

Surrender charges

Cash value projections

Policy loans

Dividends
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How To Determine The Right Policy Chapter 4
Tools & Techniques of Life
Insurance Planning

How to decipher policy illustrations (cont'd)

Surrender charges

Difference between the gross cash value and the net surrender value for the given year

Cash value projections

Based on the guaranteed interest rate versus current portfolio earnings

Questions to ask

Are the assumptions realistic?

Does the guaranteed cash value drop to zero after some duration?

When does the policy lapse?
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How To Determine The Right Policy Chapter 4
Tools & Techniques of Life
Insurance Planning

How to decipher policy illustrations (cont'd)

Policy Loans

Ledger statement will indicate the interest rate charged and if it is fixed or variable

If variable – is it reasonable over the policy period?
 Dividends

Dividends are not guaranteed

Are dividends reduced when loans are outstanding?

What interest rate must the company earn to support policy dividends?

Ledger statement should reflect how dividends are being used
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How To Determine The Right Policy Chapter 4
Tools & Techniques of Life
Insurance Planning

How to decipher policy illustrations (cont'd)

Dividends (cont'd)

Questions to ask
 Is illustration from the home office or from the agent’s computer?

Does the illustration use a reasonable interest rate assumption?
 Are dividends “puffed”?

Are cash flow amounts in one illustration comparable to those in another?

For universal life policies

What variables are incorporated in the illustration?

Insist all competitive illustrations use the same assumptions
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How To Determine The Right Policy Chapter 4
Tools & Techniques of Life
Insurance Planning

How to compare policies

The Traditional Net Cost Method
[Sum of Premiums Paid] – [Sum of Dividends] – [Net Cash Value]
Face Amount of the Policy (in thousands)
Step 1divided by the number of years index is targeting
 This measure ignores the time value of money
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How To Determine The Right Policy
 Example - The Traditional Net Cost Method *
1.
Total Premiums
2.
Minus Total Dividends
3.
Equals Total Net Premiums
4.
Cash Value Year 10
5.
Plus Terminal Dividend
6.
Minus surrender charge
7.
Equals Net Cash Value
8.
Total Premiums
9.
Minus Net Cash Value
10.
Equals Total Net Cost
$222.40
-55.10
$167.30
$160.00
+ 5.25
- 0.00
$165.25
$167.30
-165.25
$ 2.05
11.
Total Net Cost
12.
Divided by Number of Years
$ 2.05
/ 10
Equals Traditional Net Cost Per $1,000 Per Yr. = $0.205
* All premiums, dividends, and cash values are per $1,000 of coverage
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Chapter 4
Tools & Techniques of Life
Insurance Planning

How To Determine The Right Policy Chapter 4
Tools & Techniques of Life
Insurance Planning

How to compare policies (cont'd)

The Interest-Adjusted Cost Methods

Compare the cost of policies considering that money spent on premium dollars could have been invested elsewhere and earned a minimum after-tax return

Interest-Adjusted Net Surrender Cost Index

Relative measure of the cost of a policy assuming it is surrendered

Interest-Adjusted Net Payment Cost Index

Relative measure of the cost of a policy assuming the insured dies
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How To Determine The Right Policy Chapter 4
Tools & Techniques of Life
Insurance Planning
 Example – Interest Adjusted Surrender Cost Index*
1.
Total Premiums Compounded @ 5%
2.
Minus Total Dividends @ 5%
3.
Equals FV Net Premiums
4.
Cash Value Year 10
5.
Plus Terminal Dividend
6.
Minus surrender charge
7.
Equals Net Cash Value
8.
FV Net Premiums
9.
Minus Net Cash Value
10.
Equals FV Net Cost
11.
FV Net Cost
12.
Divided by Annuity Due Factor
Equals Surrender Cost Index(Per $1,000)
*All premiums, dividends and cash values are per $1,000 of coverage
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$293.72
-68.26
$225.46
$160.00
+ 5.25
- 0.00
$165.25
$225.46
- 165.25
$ 60.21
$ 60.21
/ 13.2068
$4.56

How To Determine The Right Policy

Example – Payment Cost Index*
1.
Total Premiums Compounded @ 5%
2.
Minus Total Dividends @ 5%
3.
Equals FV Net Premiums
$293.72
-68.26
$225.46
4.
FV of Net Premiums
5.
Divided by Annuity Due Factor
Equals Payment Cost Index(Per $1,000)
$225.46
/ 13.2068
$ 17.07
* All premiums, dividends and cash values are per $1,000 of coverage
Chapter 4
Tools & Techniques of Life
Insurance Planning
4 - 14