I continue to be amazed at the willingness of consumers in the market to put significant life insurance transactions in force with no outside analysis and no evident level of sophistication. Here is a very simple example.
Recently I was involved in some planning where the annual premium was $150,000 a year on a full pay basis for the desired death benefit. At least 99 out of 100 situations I get brought into involve a level premium scenario because when one hits the button on the computer, this is what comes out and little further thought or analysis is brought to the table.
In this situation we have a 77 year old individual and we played around with the premium flow. We put together a scenario where we started the contract with $100,000 a year for the first five years and increased it to $125,000 for the next 5 years. So at age 87 we have saved $375,000 of cash flow or a 25% reduction in premiums from the typical approach. In the eleventh year we start paying $150,000 for five years. Now we’re at age 92 (life expectancy). From that point we pay $200,000 and the policy is guaranteed past age 100.
What is the result? Better than a 200 basis point increase in internal rate of return (IRR) at life expectancy. The break even on an IRR basis, ignoring time value of money, is age 100. Also, given inflation, the “increasing” premium schedule is really more of a level premium than the traditional level premium schedule which is more of a decreasing premium when you think about it.
Add in time value of money and it is a whole other ball game. If one takes the spread between the level premium and the increasing premium and puts it in a side fund at a reasonable return assumption, say 7 percent, the side fund is $820,000 by age 92 when any premium is due above the $150,000. The interest alone from the side fund can pay for the increase, resulting in a total amount available (death benefit plus side fund) which is 20% greater. This works well at much more conservative return assumptions and sings at better return assumptions.
If your client is like many, they think they can do better than the insurance company anyway so why not give them the chance. I would clearly bring this strategy to the table only for clients with the appropriate financial resources and who you trust to manage it correctly.
The bottom line is that policy owners deserve a little more sophistication than they have traditionally been exposed too. They may not choose to go that route but I feel it is important to bring options to the table. They have gotten where they are by making astute financial decisions so why not help them to continue the track record?
