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Over the years, it has become apparent that too much "hide the ball" selling is going on in the financial services business. The NASD's crackdown on variable annuities is but one example of how sales tactics have led regulators to conclude that many representatives need help being honest.
A looming storm cloud on the horizon variable universal life insurance sales practices will, I believe, rain tons of water on the financial services parade. Many insurance practitioners have already weathered the universal life scandal.
They have had to explain why falling interest rates have made the premium reappear and the agents disappear. How much worse will this problem be when the cyclical performance of the stock market cannot live up to the illustrations?
Many practitioners have failed to calculate the difference between an average rate of return (ROR) and an internal rate of return (IRR). As a reminder, the average is the sum of the returns divided by the number of years. So, for instance, a return of 25% each year for 4 years and a negative 30% in year five would have an average return of 14%.
But an IRR is more complicated. It is the time-adjusted rate of return. A negative return has much more impact calculated as compounded results. The IRR for this example is 11.31%. That's a 269 basis point differential (2.69%).
Now let me ask you a question. If the illustration shows the policy earned 10%, every year for 40 years, is this realistic? Most would say, "Well, it might average that return." Precisely, it might average 10% over 40 years. After all, the large cap market has averaged more than that over the last 50 years.
But what is the IRR? What happens when the market drops 30% a couple of times along the way, but still averages 10%? See the problem?
An illustration based on 10% assumes an IRR of 10%, not an average return. Actual market performance needs to be nearly 2% (200 basis points) higher to achieve the illustrated results. How many practitioners know that? And more important, how many are disclosing this important problem to the clients?
Let's look at this issue more closely. Most clients do not understand life insurance. The fact is, all life insurance is term insurance. The only difference between "buy term and invest the difference" is where you invest this difference.
It can be in mutual funds, variable annuities, or in a whole or variable life fund. When you factor in the tax impact and expenses, a whole life or universal life policy will compare favorably to a term policy-plus side fund, especially when you consider the discipline required over 40 years.
How many practitioners explain this difference between term and permanent before they show an illustration? And how many point out how important the return is to the results projected in the illustration? Why not educate prospective clients instead of just trying to sell them?
To make education user-friendly, I developed what I call "the box." It is a simple 7-minute sales track showing how all policies are a combination of mortality costs, expense assumptions and returns. By demonstrating to prospective buyers the long-term mechanics of mortality costs, it is relatively easy to prove that no one can own term insurance past life expectancy.
Why would they? The cumulative mortality costs (the incremental death benefits payable plus reserves the carrier must collect on each life annually) for term insurance at life expectancy are the same for all companies and all policies.
