For as long as I can remember, advisors have been asking two main questions about participating whole life insurance (par). Which dividend scale is appropriate to illustrate? And, where are dividend scales going in the long term?
Often the motivation is the same behind both of those questions — you want to be conservative, but not so much that the sale is jeopardized. You also want to make informed recommendations so you can help your clients make the best decisions.
The answer to both questions is “it depends.” It depends a little on the specific par product clients are considering and a lot on what’s going to happen to interest rates and other economic factors over the next several decades.
Most companies offering par provide advisors with sales illustrations reflecting these common scenarios:
- Continuation of the current dividend scale
- The current dividend scale interest rate minus 1%
- The current dividend scale interest rate minus 2%
Clearly scenario no. 3 is the most conservative, but is it conservative enough? Is it possibly too conservative? If we go back to 1990, a period where sales illustrations showed only a continuation of the current dividend scale, many would have thought that current minus 2% would be unnecessarily conservative.
At that time, dividend interest rates had been steadily trending up for decades, and many felt the current scale was conservative enough. In reality, the dividend scale interest rates in 1990 were in the 12% range, which would be anything but a conservative rate for a long-term projection.
Recognizing the need for better understanding across the industry, the Canadian Life and Health Insurance Association (CLHIA) formed a task force on sales illustrations in 19951 . One requirement of the guidelines (published in 1997) was for insurers to begin providing at least two different scenarios, side by side, in illustrations of par and universal life. In the case of par, most companies adopted the current, current minus 1%, and current minus 2% scenarios showing potential cash values over the life of the policyholder.
If we move forward to the year 2000, when literacy around sales illustrations was on the rise, current minus 2% implied a dividend scale interest rate of around 7%. That seemed very conservative, given that it was lower than rates had been since the early 1950s. Eighteen years later, however, rates have dropped below this level.
What about today? An assumption of current minus 2% would imply long-term dividend scale interest rates in the 4% range. That’s likely lower than they have been in 150 years, and we hope that would now be considered sufficiently conservative — maybe even pessimistic, but not a worst-case scenario. I recommend you have three discussions with your clients.
*Based on male non-smoker, age 50, Sun Par Protector II, Life pay, PUA dividend option, $500,000 face amount
Discussion No. 1: your reasons for suggesting par
Some advisors recommend par to midmarket clients as a tool to fund final expenses and leave beneficiaries with a modest legacy. Usually, affluent or high-net-worth clients purchase par as a cost-effective way to fund a tax liability, to extract retained earnings from a corporation in a more tax-effective way, or to provide a well-performing alternative to fixed income in their portfolio.[Tweet this].
In each of these cases, you’ll likely compare life insurance to an alternative use for the funds, such as traditional investments.
Discussion No. 2: making a fair comparison to traditional investments
To have any meaningful comparison of two alternatives, ensure the assumptions are consistent. In other words, if you show par at today’s current dividend scale interest rate minus 2%, also compare it against the alternative investment at returns consistent with those that would result in a par policy performing at current minus 2%.
What basis would lead to a fair “apples to apples” comparison? While there is no accepted method for comparing par policies to alternative investments, the following considerations should lead to an objective analysis of PAR versus traditional investments.
If the prospect has an existing investment portfolio or a preferred asset mix in which to compare, together you can make some guesses as to its long-term rate of return. Don’t forget to determine the after-tax rate of return by factoring in the different tax treatments of interest income, capital gains, dividends, and, potentially, rental income. You can then accumulate the proposed investment’s growth. And if the funds are held corporately, you’ll need to determine the net amount after tax to the estate upon wind-up.
Follow a similar process (omitting the tax on investment earnings step) to determine the approximate long-term rate of return on the insurance company’s par account using the published asset mix.
Ideally, this result will be close to one of the dividend scale interest rates provided in the company’s illustration software. The corresponding values can be used to compare to the growth in the investment portfolio. Don’t forget that if the insurance is to be corporately owned, you’ll need to factor in the tax treatment on any amount of the death benefit that does create a Capital Dividend Account credit.
Finally, you’ll need to note some important points that the numbers alone will not reveal. For instance, the par policy values are not market-value adjusted like the alternative investment portfolio. Also, dividend scale interest rates are smoothed, and as such, the insurance policy’s performance will be much less volatile.
If advisors compare against a fully taxable investment, such as bonds, the insurance is likely going to outperform at all durations. The insurance will likely also do very well when the alternative investment portfolio has a good portion in equities, especially if the insurance is done on a joint, last-to-die basis.
This method will lead to a fair comparison, which is not arbitrary and is easier to defend than an overly conservative one. Ultimately, this approach will have a little conservatism built in. The margin between gross returns and net returns for things like investment expenses will likely be lower on the par policy than those on the alternate investment. On the fixed-income side, the insurer will have access to investments with higher yields than those available to the typical retail client.
Discussion No. 3: what to consider when choosing a par product
Several par products are available on the market today, which has been the case for almost 150 years. The same Canada-wide industry rules and oversight govern all par products. All lives insured are underwritten in a similar manner, and each par portfolio has the majority of assets invested in fixed-income instruments. Lastly, all par products should achieve the mandate of providing insurance at cost over the long term. With all these things in common, it stands to reason that all par products should result in similar performance over the long term.
So, what then are the differences worth considering when it comes to par products? To help answer this, let’s draw an analogy of par products to German luxury sedans. They each have a similar price, features and performance, but they’re different enough to justify having choice. They’re all very good, but clients must look beyond the sales illustration to make an informed buying decision. Some are a little better getting off the line, while others reach a higher top speed over the long term. If speed off the line is a priority, salespeople can guide customers toward that model.
As with cars, par products also have different design facets that clients need to understand before making an informed par product decision. All designs have their merits; the decision on which is best will rest with the preferences, or goals, of the specific client in mind.
The industry offers two options for clients that lean in one direction or the other. Some par products offer fairly high short-term liquidity. If clients are investing $100,000 annually, for example, they might be attracted to a product that has cash values exceeding total premiums paid around the five-year mark. Others won’t be that concerned about liquidity because their other assets have sufficient liquidity. For their cases, some par products have lower cash values for approximately the first 15 years and in turn provide greater growth over the long term.[Tweet this].
Using the car analogy, this would be similar to one model coming with a higher price but with more standard options. All things being equal, the lower the base premium the par product has, the lower the dividends. But lower base premium products sometimes come with higher limits on additional optional premiums for clients who want to continue putting money into their insurance policy. The more clients are attracted to the investment aspect of par insurance, the more likely they’ll lean toward the highest premium product that allows for more room to continue investing.
All par products disclose that dividends are dependent on the investment, mortality and expense experience of the par block of business overall. What isn’t disclosed fully is the relative weight of these three components, which will vary from product to product. There will be differences, especially on the investment side, which is generally considered the largest contributor to annual par dividends.
This apparent gap in disclosure has to do with the difficulty explaining intricate actuarial engineering principles. Going back to our analogy, car lovers usually won’t receive an explanation about exactly what happens between the time they put gas in the tank and the time the rubber on their tires starts to smoke.
You can help clients look at the underlying par portfolio for each of the par products they’re considering. Different risk appetites require different investment mixes. For example, different portfolios would include higher or lower percentages of segments such as real estate, mortgages, equities, government bonds, corporate bonds, private fixed income and cash.
The insurance sales illustration has been the tool of choice for many advisors when presenting product proposals to clients. It is part of the equation, but an informed decision goes far beyond the sales illustration. After all, the official sole purpose of a sales illustration — as defined in the CLHIA guideline — is to inform clients and prospective clients about specific features and operations of the policy they might consider buying. It’s not intended to be used to predict performance or to compare non-guaranteed values to other policy plans or between policies of different companies.
With structural differences in product designs, subtle differences in underlying investments and par’s return smoothing processes, you have a lot to show clients before they make an informed decision.
You might also like…
- How you run your practice affects the value of your advice
- Why it’s important to connect with female clients
- When estate settlement costs your clients more than money
This article is intended for information purposes only. Sun Life Assurance Company of Canada has not been engaged for the purpose of providing legal, accounting, taxation, or other professional advice. No one should act upon the examples/information without a thorough examination of the legal/tax situation with their own professional advisor, after the facts of the specific case are considered.
“This article was published in the [September 2015] issue of FORUM magazine. Printed with permission from Advocis, The Financial Advisors Association of Canada.”
1 Wayne Miller was one of the founding members of this task force and served as Chair.
Wayne Miller is an Associate Vice-President, Strategic Business Development, Individual Insurance and Wealth, Sun Life Financial.
Over the course of Wayne’s almost 30 years at Sun Life Financial, his respect for advisors has only grown. As the holder of Associate designations in both the Society of Actuaries and Canadian Institute of Actuaries, he spent the first 10 years of his career in product development, with the balance being in Marketing and Distribution. In his current role as Associate Vice-President, Strategic Business Development, Wayne oversees a team of thought leaders that focuses on professional development, practice management, and market development. Wayne holds an Honours BA in Mathematics, Actuarial Science from the University of Waterloo. He has many industry accolades, including his associateships in the Society of Actuaries and the Canadian Institute of Actuaries; his membership in Advocis, GAMA and CALU; as a conference speaker at events sponsored by the CIA, CLHIA, CALU, CAILBA and Advocis; and through his published articles in Advocis’ Forum magazine.
Wayne is leading the advice revolution. He’s a founding member and past Chair of CLHIA’s Task Force on Sales Illustrations, which mandated increased disclosure and sensitivity analysis for life insurance sales illustrations. He developed the industry’s first disclosure booklet on participating life insurance; co-authored a white paper on life insurance as an asset class; and authored many published articles on topics ranging from demutualization, industry trends, product mechanics and suitability.