INS312 PP Chapter 17 Policy Illustrations
Problems with Policy Illustrations
* No adjustment of premium payments in different years for interest (TVM). * No adjustment for policy values for interest from different periods. $1.00 today is worth more than $1.00 in the future. - Using tax rates significantly different from the prospect's considered deceptive sales practices. - Universal life annual reports must show any outstanding policy loans and cash surrender value after any surrender charges.
Cost Index Basic
+ Total Premiums (given # years) (-) Dividends (-) Cash Value (if applicable) (=) Insurance Cost *Adjust Cost/year *Adjust Cost/1000
These methods can be used to compare similar or different types of policies (eg. WL vs. Term)
- Cash Accumulation Method +"Buy term, Invest the Difference" + Hold DB level and compare CV and side fund - Equal Outlay Method + Hold premium level, compare Death Benefit - Comparisons that Isolate Interest Rates +Comparative Interest Rate Method +Belth Yearly Rate-of-Return Method +Belth Yearly Price-of-Protection Method
Policy Comparisons
- Compare only similar plans of insurance. (lower the number, less costly) - Compare same type of insurance plans; different companies. - Ignore small variations in the cost index numbers. - Compare only new policies, not replacement. - Type of policy you buy should not be based solely on a cost index.
Interest-adjusted Indexes
- Developed by NAIC to compare similar policies fairly: eg. WL to WL comparison. - Not proper to compare different types of policies + (e.g. WL and term). - Use a 5% interest rate to make comparisons easier and consistent. - Considers TVM + interest and opportunity cost
NAIC Model Illustration Regulation Prohibits:
- Representing policy as anything other than life insurance. - Providing applicant with incomplete illustration. - Using an illustration that is not "self-supporting". - Stating or implying non-guaranteed elements are guaranteed. - Using the term "vanishing premium" to imply policy is paid up. - Using an illustration more favorable than an illustration based on current scale of insurer.
Traditional net cost method
- Total CV - premiums paid = "cost" (no time value of money taken into account - interest)
Methods of Comparing Costs
- Traditional Net Cost Method - Interest-adjusted Indexes + Net cost = (FV-FV Dividends)/ FVAD(Interest factor) - Net Payment Index - death benefit is focus (no cash value considered) - Surrender Cost Index- cost if policy surrendered and CV included - These indexes appear on policy NAIC illustrations and policy summaries
Cost Indices Calculation
-David purchased a $100,000 participating whole life policy. The annual premium is $2,280. Projected dividends for the first 20 years are $15,624. The cash value after 20 years will be $35,260. If the premiums were invested at 5 percent for 20 years, the premiums would grow to $79,156. If the dividends were accumulated at 5 percent for 20 years, they would grow to be $24,400. The amount to which $1 deposited annually will accumulate in 20 years at 5 percent is $34.719. Based on this information, calculate the following cost indices. -Traditional Net Cost Method -Surrender Cost Index -Net Payment Index
Policy Illustrations
-No uniform standards prior to 1997. - Companies created "illustration wars". +Used very favorable (unrealistic) assumptions about mortality, interest, expense and lapse experience. - NAIC Interest-adjusted indexes required -NAIC Model regulation (see list). * MUST show guaranteed as well as non-guaranteed elements.
Traditional Net Cost Method
Total Premiums 20 years $45,600 (-) Accumulated Dividends 20 years 15,624 (-) Cash Value end of 20 years 35,260 (=) Insurance cost 20 years -5,284 Cost per year -5,284/20 -264.20 Cost /year/1000 -264.0/100 -2.64 No time value of money No interest on premium Negative means premium is less than value added
Surrender Cost Index
Total Premiums 20 years accumulated @5% $79,156 (-) Dividends for 20 years accumulated @5% 24,400 (-) Cash Value EOY 20 35,260 (=) Insurance Cost interest adjusted 20 years $19,496 (/) FVIFAD $1.00 for 20 yrs. @5% 34.719 (=) Cost/year interest adjusted $561.54 (/) # of 1000s (100) 5.61
Net Payment Cost Index
Total Premiums 20 years accumulated @5% $79,156 (-) Dividends for 20 years accumulated @5% 24,400 (=) Insurance Cost interest adjusted 20 years $54,756 (/) FVIFAD $1.00 for 20 yrs. @5% 34.719 (=) Cost/year interest adjusted $1,575.44 (/) # of 1000s (100) 15.75