With the powerful new financial planning tools that are now available, advisors can measure the planning value of insurance and annuity products to clients.
What practitioners intuited all along–that such tools would be of great added value–is being proven true. Now, they can quantify.
Combined with modern financial engineering calculations, industry professionals also can see the difference between the client's value and Wall Street's manufacturing cost. This is the "planning value added," which can be shared among clients, the distribution system and product manufacturers. Knowing this spread can be of great help in effective product design.
Let's define the terms:
Planning value: This refers to the liquid general investments a client would need to meet financial planning objectives, minus the amount needed if the life or annuity policy or other instrument is in place. This is calculated using financial planning software that takes probabilities for investment and longevity risk into account. The value will vary from client to client, according to financial condition and objective.
Pure manufacturing cost: This is the cost to fund the policy benefits, net of premiums, on a risk-free investment basis. It excludes expenses, distribution costs, cost of capital to absorb risk and profit. It is calculated using modern financial theory. It does not depend on the client or the insurance company.
Planning value added: This refers to the "planning value" less the "pure manufacturing cost." It's available for expenses, distribution, cost of capital, profit to insurer and financial planning benefit to client, as determined by market forces.
Value ratio: This is the "planning value" divided by "pure manufacturing cost."
As an example, look at the much touted but much underused immediate annuity.
Take a male age 62, wanting an income of $60,000 per year that keeps up with inflation, with $22,000 in Social Security. He wants a 1% or less probability that he will run out of money. He is considering an immediate annuity with $25,000 in annual income. He can meet his planning objectives with $1,580,000 in general investments.
Now, let's look at what might happen if he includes an immediate annuity in the planning. The following are examples with three different types of immediate annuities:
