Evaluating a Life Insurance Policy

Evaluating a policy. The most commonly used tool for evaluating a life insurance policy is the policy’s illustration. A life insurance policy illustration is prepared by an insurer to demonstrate how a policy is structured and how it may perform over an insured’s lifetime using a set of projections that include both guaranteed and non-guaranteed elements. As to the non-guaranteed elements, it is critical to understand that the projections reflect a set of assumptions as to the insurer’s mortality experience, investment returns, loading charges and lapse rates. .The key to an illustration’s credibility, therefore, is the reasonableness of those underlying assumptions, and the best indication of their reasonable­ness is the insurer’s past performance. Information on an insurer’s performance may be obtained from a company agent, the state insurance department, the NAIC and the SEC. In addition, The Society of Financial Service Professionals provides illustration questionnaires for variable and non-variable products to insurers that are completed on a voluntary basis. The questions are designed to determine whether the insurers’ illustrations are predicated on realistic figures and to gain an indication of how much actual policy values may vary. This information is available to agents and other professional advisors for the benefit of prospective purchasers. Finally, the A.M. Best Company provides Bests’ Key Rating Guide, which gives five-year financial summaries of insurance companies.

Comparing policies. One approach to comparing policies utilizes various mathematical cost comparison methods. The problem with this approach is that it is likely to only be attractive to the mathe­matically inclined. Further, such methods rely upon illustrated policy values that may vary greatly from actual values for a particular company. Moreover, the underlying basis for one company’s illustration may be different from the next, so that it is difficult to compare apples to apples even when the same type of policy is involved.

Another way of obtaining and comparing the costs of sim­ilar policies is to use the “Interest Adjusted Net Cost” (IANC) indexes (net payment cost index and surrender cost index) that are required by the NAIC Life Insurance Model Regulation and regularly provided by many insurers in their illustrations. These figures take into account the time value of money and give the cost per $1,000 of death benefits (guaranteed & non-guaranteed) and cash values.

When using illustrations for comparison purposes, always make sure that the agent provides all the pages and not just a summary or select number of pages. In addition, ask for projections using different interest rates that reflect what might realistically be expected to happen over the long term and, in setting such rates, consider the prospective policyholder’s tolerance for risk. Remember also that comparisons based on illustrated figures are only as credible as the companies that prepare them. Further, a numerical comparison of policies has a deceiving quality of precision that does not exist in the real world. Consequently, rather than just searching for what appears to be the cheapest coverage, the analysis should focus on finding a policy that is suitable for the policyholder’s needs and is issued by a company that is most likely to provide good service and be around to fulfill its guaranteed promises and reasonable projections. In that regard, valuable assistance may be obtained from an experienced agent with appropriate credentials, such as a CLU (Chartered Life Underwriter), and suitable references.