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.