When $500 Feels Expensive and $20 Million Doesn’t
By Bill Boersma
I know why people act the way they do. Because the human mind isn’t the most rational thing.
I’ve regularly had advisors and policy owners tell me they wish there was an objective, third party source of information for life insurance analysis, and given the state of affairs of so many policies, it would certainly be worth paying for.
But then, when push comes to shove, many of them won’t. What I’ve discovered is that the best way to get money out of people is to not have them realize they’re paying it. Yes, that sounds odd, but I mean that if they aren’t actually writing a check, then they don’t realize how much they’re paying. It’s why so many things in the world have gone to a subscription-based service.
A policy owner doesn’t write a check to an insurance agent for commissions or to the insurance company for mortality charges or fees, whether it’s life insurance, health insurance or P&C coverage. They pay the premium and that’s it.
Think about investment management. Here is a hypothetical example: $500,000 growing at 8% over 30 years grows to $5 million. Pull out your financial calculator and you’ll come up with the same numbers. Now, assume the financial advisor charges a 1% management fee. What do you think the $500,000 grows to? $3.8 million. The management fee costs $1.2 million or 24% of what the investment would have grown to. If the client paid the fees out of pocket on the investment balance annually, the fees would have totaled $600,000 and the time value of money on fees over the thirty years would be $1,630,000.
Do you think for a moment that the client would have written $600,000 in checks to the advisor over the years? It’s brilliant, really.
Back to life insurance. I provide the third party, objective life insurance analysis policy owners say they’ll pay for, but let’s look at a case example.
A 70-year-old gentleman was buying a $10 million policy. I took the liberty of making a visual of the fees in the policy.
This is the fee I would charge to run independent, third-party modeling that would calculate the probability of success of his policy making it to age 100. I use the Life Insurance Sustainability Analytics (LISA) tool to assist in my modeling and analysis. The cumulative internal fees for the policy from inception through age 100 are almost $20 million. The expenses in the very first month of the policy are $122,000. He opted not to do the modeling.
Is this rational? The commissions paid out of the gate exceed $300,000 and that’s only a part of the fees. I’m not begrudging the agent for that. What I am astounded at is the policy owner would make a decision to ignore that and not pay $500 for the report. Yes, only $500.
Here’s the biggest issue; he has no idea what the assumptions his policy was built on mean. He didn’t choose any of the variables. He didn’t understand how underlying assumptions could impact the performance of his policy.
Maybe the modeling I could do might direct him to structure things a little differently. It turns out the policy was built thinly funded leaving it quite susceptible to modest deviations from the sterile assumptions the carrier illustration system is bound by. Yes, the sales ledger shows the policy lasting to age 100 and the modeling results in a 97% probability of making it to 100, but what if there’s a bobble?
Reducing the cap rate of the product to 10% reduces the probability of success to 57% and reducing it to 8% brings it to 4%. At slightly better funding, 3% greater, the probability of success as illustrated is 100%. At a 10% cap it’s still 100%. At an 8% cap it’s 98%. He might or might not choose to make the change, but he certainly understands the consequences. The probabilities are generated through LISA and are based on hypothetical modeling that reflects certain assumptions regarding market conditions, policy performance and expenses. Results will very with each use and over time.
Bill Boersma is a CLU, AEP and LIC and the founder and owner of OC Consulting Group. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info or email at bill@oc-lic.com or call at 616-456-1000.
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Securities offered through Valmark Securities, Inc. Member FINRA, SIPC. Investment Advisory Services offered through Valmark Advisers, Inc. a SEC Registered Investment Advisor.
OC Consulting Group and its affiliates are separate entities from Valmark Securities, Inc. and Valmark Advisers, Inc.
The examples given are for illustrative purposes only and not intended to represent the experience of all clients. Actual results will vary.
The LISA (Life Insurance Sustainability Analytics) software uses Monte Carlo simulations to illustrate potential policy outcomes based on assumed cap rates, crediting methods, and hypothetical investment returns. Results generated by LISA are hypothetical in nature, do not guarantee future performance, and should not be relied upon as a guarantee of any specific policy result. These assumptions may not reflect actual future performance.
