How Life Insurance Policy Reviews Trip Up Fiduciary Advisors

This may sound like an esoteric difference, the authors warn, but the practical effect is significant and can result in clients and advisors making poorly informed decisions.

To make the point, the FPA report considers the theoretical example of a "45-year-old, extra-healthy client" needing $1 million of permanent life insurance and wanting cash value as an exit strategy in case he no longer needs the coverage.

In such a case, certified financial planners can contact a trusted life insurance broker or the insurance services department at their financial institution, who in turn contacts their brokerage general agency or insurance marketing organization for premium quotes payable for 20 years and calculated using a 5% interest rate, so that quotes can be compared to determine which product is best for this client.

In the example, the CFP professional receives illustrations for two products, including a traditional universal life product and an indexed universal life product. The products are from two well-known insurers that are both highly rated for financial strength and claims-paying ability, and both illustrations prominently display the requested 5% assumed rate of return.

The quote for the universal life product comes in at $8,500, however, while the premium for the indexed universal life product is about $13,000. No competition, right? Wrong, according to the report.

"Comparing hypothetical premiums, cash values and death benefits does not necessarily identify the product with the lower costs," the authors warn. "As such, hypothetical illustration comparisons are useless as due diligence for product recommendations, and they can expose CFP professionals to claims of breach of duty to act with care, skill, prudence and diligence."

Deeper Analysis Needed

According to the FPA report, because insurance costs vary from year to year, comparing costs becomes more practical when the amounts are "normalized" to account for differences in amounts and timing of the charges in different policies.

Normalized values, provided by services such as Veralytic, can then be compared with industry benchmarks for each of the life insurance policy's pricing components.

"This practice of benchmarking is well-established in the financial services industry, where a financial product's performance is compared to a standard, independent point of reference," the authors explain.

For example, the performance of a mutual fund is often compared with the Dow Jones Industrial Average, the S&P 500, the Nasdaq or the Wilshire 5000, depending on the fund's investment objective.

"Likewise, comparing [insurance features] and expenses for a given life insurance product to industry standard mortality tables and industry aggregate expense ratios reveals actual cost competitiveness or excessiveness," the report argues.

The authors go on to dissect several cost-influencing factors that advisors should understand if they want to truly help their clients weigh and select life insurance policies, including fixed administrative expenses, premium loads and cash-value-based wrap fees, among others.

Ultimately, the authors conclude, due diligence for life insurance product recommendations should consider whether expected cost of insurance charges are consistent with mortality experience, whether expected policy expenses are consistent with operating experience, and whether expected policy interest and earnings are consistent with historical performance of both invested assets underlying policy cash values and corresponding asset class benchmarks.

"The NAIC Life Insurance Illustrations Model Regulation generally ignores these risks," the authors warn, "instead permitting both mortality improvements and operating gains (albeit with disclosures in footnotes not often read by planners or clients), as well as a wide range of interest/earnings assumptions that have too often proven to be unreasonable."

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