The policy illustration or ledger statement is the principal source of financial information regarding a new-issue policy.
The separate chapters on the various types of policies provide ledger statement illustrations and describe in considerable detail what to look for in these statements. Here, we present a general overview. Understanding these ledger statements is important because the information they provide serves as the basis for the various policy comparison measures that are discussed below.
The first step in understanding a policy illustration is to identify the columns that state the following:
- Yearly premium payments
- Year-end policy cash values
- Projected policy dividends
- Cumulative cash value at given policy durations
- The death benefit from the basic policy
- The death benefit provided by any dividends
The critical questions are:
1. What does the client pay, year by year— compared to what he gets if he lives and what his family receives if he dies?
2. What portion of those amounts does the insurer guarantee—and what portion of those amounts are just insurer projections?
3. What interest or other assumptions do insurers build into these figures?
Financial services professionals should examine a policy illustration with particular emphasis on the following:
- Surrender charges
- Cash value projections
- Policy loans
Determine what the company charges if the client surrenders the policy in a given year by looking at the cash value columns. Where there are two columns for cash values—one that reflects the net surrender value of the contract and the other, the year-end cash value for the policy—the difference between these two amounts is the surrender charge for the given year.
Cash Value Projections
Ascertain the “premium level safety” by looking at the cash value projections on universal life and interest-sensitive life products. It is common under these two types of policies to show future cash values based on:
1. the guaranteed interest rate; and
2. one or more higher interest rates related to either:
a. current portfolio earnings; or
b. whatever earnings level the agent has selected for the illustration.
Question the long-term reasonableness of the assumptions. Are they unrealistic? Does the cash value associated with the guaranteed interest rate drop to zero after some years of duration? This indicates that the premium being charged for the contract will at that point become inadequate to support the coverage in force if the insurer is only able to credit cash values with the guaranteed interest rate. The client will be forced to pay higher premiums unless the contract earns interest higher than the guaranteed rate. If the illustration shows positive cash values at all policy durations, the premium will be adequate to carry the policy indefinitely.
The notes to the ledger statement should explain what interest rate the insurer charges on policy loans and if the rate is fixed or variable. If the rate is variable, is the rate being used for illustration reasonable over the period shown?
Check the illustration to see if loans are part of a systematic plan of borrowing to pay premiums. This is called a “minimum deposit” plan. Although no longer a popular approach to financing insurance premium payments, this is evidenced by a regular pattern of increasing outstanding loan balances where the increases are tied closely to the interest rate applicable to the previous outstanding balance and the premium payment due under the contract.
Remember that dividends are not guaranteed. Many insurance companies have recently, and significantly, reduced dividends below their original projections. If the ledger statement shows policy loans, the notes to the ledger statement should explain whether dividends are reduced when loans are outstanding. Check to see whether the projected dividends reflect reductions attributable to any projected policy loans. Also, determine what interest rate the company assumes it must earn to pay the projected dividends. If the assumed interest rate seems too high or too optimistic over a period of time, run another ledger with projected dividends based on a more supportable long-run interest assumption. Also, check the interest rate that the insurer will pay on any dividend left with it to earn interest. (The interest is currently taxable, even though the dividend itself will not be taxable to the policyowner.)
The ledger statement should reflect how the dividends will be used. For example, if the client desires additional insurance to build up at net (no commission or overhead) cost, dividends could be used to purchase “paid-up additional insurance” (“paid-up ads”) or to purchase one-year term insurance (also a very cost-effective purchase).
Alternatively, policyowners could use the dividends to reduce premiums or as additional premiums (“vanishing premium” option) or to repay any projected policy loans. Obtain a ledger statement with dividends used in whatever manner is planned.
Here are some questions to ask the insurer/agent:
1. Is the illustration from the home office or is it printed on the agent’s (or some other source’s) computer? Demand a ledger printout from the insurance company’s home office to compare one policy with another.
2. Is the interest rate used reasonable over a long period of time?
3. Are dividends “puffed”? (Does a comparison of the company’s past projected dividends with its past actual dividends—or with the records of other companies’ products you are examining—suggest that the company has been overly optimistic?) This can have a significant impact upon when, or if, premiums will “vanish” or when they will unexpectedly reappear.
4. Are cash flow amounts in one illustration comparable with those in another? Cash flow amounts will be similar only if death benefit amounts and premium payments, as well as any projected policy loans or withdrawals, are for similar amounts for each policy’s duration. The more the values of these variables differ from one illustration to another, the less meaningful are differences in cash values, death benefits, or dividends levels.
5. In comparing universal life products, demand to know what variables are incorporated in the illustration and then insist that all competitive illustrations use the same (reasonable) assumptions.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM