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Today we're discussing the other “i” word–illustration. We are diving into how illustrations are manipulated to sell the sizzle and not so much about focusing on the substance.
It seems that far too many of the people working in the marketing department feel that they need to really “push the envelope” in terms of illustrating projected product performance. In other words, they like to distort reality to make their products seem a bit more attractive than they would otherwise be.
This is particularly true when it comes to variable and indexed products as it is somewhat easier to inflate things based on using unrealistic returns on the investment sub-accounts and/or indexed accounts.
We have seen illustrations that used static returns of 8-12% depending on the product and when we saw them as the “standards” of what is allowed have changed over the last few years.
There really is no academic argument as to why anything should be illustrated at rates this high, however, someone in marketing decided that it makes their product look really nice when shown these sorts of rates and that will convince people to buy.
What's more…
We've expressed our displeasure with more than one marketing organization who chooses to present products in such an unrealistic way. Wanna guess their response?
Shoulder Shrugs
Lots of shoulder shrugs and pseudo-justifications for how they are illustrating the product(s).
What we are constantly trying to communicate with them is that WE have real clients–people who we actually like and plan on having around as our clients for many years into the future. The very same people who will be around to ask us why things are working out so well 15 or 20 years down the road.
At some point (hopefully often) we're going to talk to our clients again.
There are far too many agents, financial advisors and marketing organizations using inflated rates of return in their illustrations and then justifying them by pointing to some cherry-picked historical time frame. Sure, you can always find some data to back your claim. That's what attorneys do in courtrooms on a daily basis.
But that doesn't help your clients in a real world scenario when they have real money at stake. The truth is that our clients don't live in some hypothetical parallel universe, they live right here, right now and are actually staking their financial future (at least in part) on the financial product(s) and/or strategies that they use and that we recommended for them.
Beware the loan rate
Not to be ignored is the loan interest rate. This of course is only a concern when illustrating loans from a life insurance policy and manipulating this number can be just as dangerous as over-projecting the hypothetical return.
Some companies will allow agents/advisors to illustrate an artificially low interest rate on loans which of course causes income projections to be overstated. Why? Because by pushing the loan rate down you have increased the positive spread between the loan interest and the hypothetical return. Obviously this will cause the policy to project much better returns than it would otherwise be capable of producing.
And in some ways this sort of manipulation is more insidious as most people fail to give the loan rate or provisions much more than passing glance.
Our Illustration Philosophy and Why It's Better
Our approach is to make things look as bad as possible because we think there's a pretty good chance that they will actually do better.
That's pretty clear right?
Seriously, we believe that if our clients are happy with the illustrations we show them (that aren't always so great) they'll likely be pretty happy in the future.
Our guiding number for indexed universal life insurance has been and will continue to be somewhere right around 6%. And we have gotten a ton of pushback from a lot of people that we are way under projecting.
I can assure you, we have conducted ample research and have concluded that there is a high probability that the indexed universal life insurance contracts we choose to sell will return something greater than 6%.
However…
We don't believe in pushing things right up to the limit for illustrative purposes. Great if it works out that way but we don't think its prudent to fund a life insurance policy based on the chance that you might achieve some some hypothetically higher rate.
Another problem
When you are illustrating a life insurance policy there's a different set of circumstances at play than if you were projecting an artificially high rate of return on say…a mutual fund.
If someone were to project that you might get an 8% return over 25 years in a mutual fund investment and you didn't achieve that, what's the worst that would happen? You just wouldn't have the amount of money that you thought you would have.
On the other hand, with a life insurance policy, your projected premium and the net amount risk are very much tied to the performance of the policy over time. The cost of insurance inside any type of universal life insurance is always increasing, so a portion of cash value is used to offset that expense over time by decreasing the net amount at risk for the insurance company.
Sidenote: We have a few posts that offer a more in-depth understanding of universal life insurance mechanics if you're interested:
The Basics of Life Insurance III: Universal Life Insurance
Universal Life Insurance is NOT the Cheap Alternative to Whole Life Insurance
Why should this matter? Well, if a universal life insurance policy (any type–current assumption, indexed universal or variable) is underfunded and it does not perform as projected, you can run into a set of compounding circumstances that will not make for happy days.
Just ask some of the people who bought universal life insurance back in the early 1980s that had current interest rates of 14%. Guess what happened?
Interest rates fell, cost of insurance increased as planned but they kept paying the same premium. This let to a convergence of bad things that ended with them either having to add much more money to keep their policies in force or lapsing the policy because they couldn't afford to add the premium required to keep the policy.
Either way, not a good experience for those people.
What's the lesson here? You need to work with a competent agent/advisor that understands the mechanics of the product and/or strategy that they are recommending to you. We are that competent resource for our clients, if you'd like to talk with us–contact us here.
Hello Brandon,
I am a subscriber to your financial iTunes and enjoy the nonsense approach that you and Brantley bring to your discussions.
I am also an insurance professional and specialize in the design of high income dividend-paying whole life insurance policies.
In most situations, I use Penn Mutual whole life for its income generating ability and the flexibility of its PUA rider.
Last week, I prepared an illustration for a 21-year old male preferred Non-Tobacco in Florida paying premiums for just seven years: $17,000 in years 1 and 2 and $12,000 in years 3 through 7. The purpose was to maximize his retirement income from age 71 through age 85. The Penn Mutual illustration using Guarantee Choice Whole Life gave an annual retirement income of over $98,000.
Since the father of the client already had an insurance policy with American United (One America) he asked me to run a similar proposal with them. I generated an illustration using its Legacy 121 whole life and to my surprise the most annual retirement income I could generate was close to $54,000.
Brandon, have you experienced such a wide discrepancy in results when you do your designs? From close to $54,000 to over $98,000!
I would appreciate your comments on my experience.
Thank you,
Pedro Palicio
Hi Pedro,
Yes we have noticed this. And One America regretfully has trailed others like Penn Mutual in comparisons we’ve done over the last couple of years. It’s yet one more example of our caution about believing the non-direct recognition is superior. One America, a non-direct recognition contract, trails Penn, a direct recognition contract, considerably in your example and in several we’ve run.
We’ve had others who profess expertise in One America run proposals to compare as well, and they come up with the same results we do.