The performance of a life insurance policy is determined by four basic components, which are earnings (interest rates), mortality, administrative and overhead expenses, and persistency, also known as the lapse component.
Interest rates tend to change the most, which has a greater impact on the performance of a policy than most of the other components. However, a small change in mortality rates will have the greatest impact on the policy performance, but this doesn’t occur very often.
There are three basic types of earning – dividends and credited interest rates on traditional life insurance products, participation rates in a certain equity index on equity-indexed universal life, and fixed and variable accounts on variable life insurance products.
This is the cost of pure life insurance protection – basically, how much the company charges for providing life insurance (i.e., how much they feel there is at risk and how much they can lose). This figure is based on experience tables developed by actuaries and on actual mortality experiences, which can vary from company-to-company.
Larger companies determine their own mortality charges, while smaller companies rely on industry-wide statistics.
Administrative and Overhead Expenses
Includes all the operating costs that the life insurance insurer incurs in the course of doing business.
These costs fall into four basic categories: cost of facilities, data processing, employees/labor, and sales expenses, which includes commissions, marketing costs, sales offices, etc.
Persistency (sometimes referred to as lapse component)
This is a measurement of how long a life insurance company’s policies are staying in-force (active). This is an important consideration for life insurance companies, because of the impact it has on the company.
When policy owners terminate their coverage prematurely, this can result in a loss to the company, especially on permanent policies that only have been in-force for a short period.
If a company has a high level of early lapses, which is the same as low persistency rate, then there is a problem somewhere. Watch out if this is the case with a company you plan on using.
Tony Steuer is an author and advocate for financial preparedness. Tony Steuer, CLU, LA, CPFFE, helps people make sense of the financial world in a way that’s easy for them to understand. His books including, “GET READY!,” “Insurance Made Easy,” and “Questions and Answers on Life Insurance,” have won numerous awards. Tony is the founder of the GET READY! Initiative which includes the GET READY! financial organization system, the GET READY! Financial Preparedness Club, GET READY! Podcast, and the GET READY! Financial Principles, a best practices playbook for the financial services industry. Tony served as long-term member of the California Department of Insurance Curriculum Board. Tony is regularly featured in the media including the New York Times, the Washington Post, Fast Company, and other media. He has also appeared as a guest on television shows, such as ABC’s “Seven on Your Side.” Visit https://tonysteuer.com/ to join the GET READY! Financial Preparedness Club and access free resources.