Internal Rate of Return on Underwriting

July 16th, 2019 No comments

Pay attention to where it counts

It’s interesting to see where people put effort and concern and where they don’t.  Parents might go to extreme lengths to keep a child safe and healthy by purchasing the best reviewed products and most healthy food and participating in developmental activities.  However, without even thinking about it, they’ll then put that kid in a car to run to the store, and that’s the most endangering thing a parent could do to a kid according to the Center for Disease Control and the World Health Organization.  But do any of us use that as a reason to not visit grandma?

No.  We use modern car seats and seatbelts and review crash test data and hopefully don’t text and drive.  We do what’s needed to improve the chances of a positive outcome.  In reality, we’re simply not lending credence to those things we’re very comfortable with and that don’t make us stop and think.  Sometimes worse, we make decisions based on unsubstantiated rationale.  After all, we’re victims of emotion at times.  The same emotion that makes us go to some ridiculous length to prevent something from happening that, in all likelihood, is never going to happen is the same emotion that may drive someone to buy a tiny, gas efficient car to save the planet when the full size SUV is going to protect your kid far better.

Focusing Where it Matters

It’s the same thing with life insurance and underwriting.  Where’s all the focus?  The order of process is often inverted from what it actually should be.  Quality of carrier is important.  Competitiveness of premium is nice.  Relationship with agent is helpful.  But in too few situations is underwriting the leading and driving factor.  I’ll suggest it should be higher on the list more often.  How do I know it’s not?  I witness in the market.  It’s also because of the percentage of time the policy in force is from the same insurance company listed on the agent’s business card.  Statistically, this can’t happen if sufficient attention is paid to optimizing underwriting. Personal experience in this market over the past few decades leads me to understand this very clearly.

Underwriting is where the rubber meets the road.  The initial rationale to do business with carrier A, B or C or to do business with the insurance company that ranks better on the spreadsheet might pale in comparison to where an underwriting offer might point us.

Putting Numbers To It

Here’s a simple example.  Let’s say we have a 50 year guy who wants $10 million of permanent insurance.  I’ll run some guaranteed universal life numbers on a quote engine I have access to.  At preferred rates with one well know company (carrier A), the premium is $100,000.  At standard rates, it’s $130,000.  That’s a 30% increase in premium.  Maybe standard is the very best rate he’ll get anywhere in the market.  I’ll bet not.  I’ll also bet that standard rate is what will very often be put in force.  The question is, how much work is it worth to find something better?

Let’s put this into perspective.  Assuming death at age 85, the internal rate of return (IRR) on premium to death benefit is 5.24% assuming preferred rates and 4.02% at standard rates.  That’s a 122 basis point improvement on the deal.  What if your financial advisor could get you an assured 122 basis point improvement on your investments?  What would that be worth?  That’s a 30 % improvement in performance.  The net present value of that premium spread at 5% is a half million dollars.  Might that be worth some effort?  It’s not even your effort because you’re telling the agent to do it.  For the commission on this case, he’d better be willing to shuffle some more paperwork and turn over a few more stones.  It might be good to understand that the better the underwriting offer, the lower the commission.  I’ve actually seen agents disappointed to get a better offer than expected because of what it did to their commissions.

Changing Horses Mid-Stream

Assuming we can’t negotiate from standard to preferred with carrier A, will another insurance company look at it differently?  All the time.  Let’s go back to the hypothetical spreadsheet.  Suppose another insurance carrier (carrier B) showed preferred rates at $105,000, which wasn’t paid attention to because $100,000 looked better.  If we could get carrier B to go for preferred, then $105,000 is meaningfully better than $130,000, all other things being equal.

In fact, if I looked at the insurance company 10 spots down on the list of competitive companies, an option that no one is going to consider when deciding how to move forward, the spread in IRR between the 10th place product and the first place product on the list is 50 basis points less than the spread between preferred and standard.  The least attractive option, based on price alone, when initially reviewing choices, may be the best option if their underwriting department comes through.

Let’s take it further.  We’ll assume the client was rated at a table D.  Now the premium is $200,000.  If standard at $130,000 can be wrangled from another carrier, then we’re looking at better than a 200 basis point improvement and a return that’s over 100% better.  Is this feasible?  If you’re working with someone who know’s what he’s doing, absolutely.  A rabbit’s not going to appear out of the hat every time but even a table C is better, and I’ve seen such a case go to preferred best that would drive the premium below $100,000.  I kid you not.

It’s the Same Story with Second-to-Die

The same dynamics apply for survivorship cases.  When two preferreds turn into a preferred and standard, premium increases 15%.  With one at table D, it’s a 30% increase.  Some research and negotiating to find a 50 to 100 basis point improvement in return would prove to be worth some effort.

It’s not always what’s staring you in the face that you have to be concerned about.  That stuff is easy.  It’s the stuff you might not think about, if you’re not deeply involving in the industry, that might offer the biggest return.  If that no-so-great-offer is from the insurance company on the agent’s card, direct him go outside to find a company that will do better.  Don’t let anyone tell you “I have a 30 year relationship with this underwriter, and if they won’t give you better, no one will.”

Someone who really gets this might be helping a client, for whom underwriting might prove to be tricky, prepare medical files for a year before the application process even commences.  There’s both an art and a science to this.

So, don’t be too worried that your kid’s food might not be organic because I can assure you there will be many and much more dangerous encounters on a daily basis.  Prioritize concern and effort where it matters.

 

Bill Boersma is a CLU, AEP and LIC.  More information can be found at www.oc-lic.com, www.BillBoersmaOnLifeInsurance.info and www.XpertLifeInsAdvice.com or email at bill@oc-lic.com.

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Letters of Explanation: IUL Premium Financing Risk

June 17th, 2019 No comments

Dear Mrs. Client:

Last week I promised you some numbers to put into perspective my thoughts that premium financed Indexed Universal Life isn’t what you think it might be.

The spreadsheet you showed me some time ago assumes an annual loan of $700,000 for 13 years.  This is used to purchase a policy that assumed roughly a 7% annual crediting.  This may sound conservative for an S&P 500 Index return but it isn’t if you understand how Index funds work.  A significant issue is that the dividends aren’t included in the return and historically dividends make up at least a couple hundred basis points of the return and sometime 500 basis points.  There are entire decades where the dividends are greater than 50% of the return of the S&P 500.


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The Bastardization of Premium Financing

June 10th, 2019 No comments

What you see isn’t necessarily what you get.

Wealthy people and business owners have always leveraged money and assumed risk but starting about a decade ago, after the 2008 crash, premium financing has been driven by very low London Interbank Offered Rate (LIBOR) based borrowing rates and aggressive return assumptions on insurance products that are easy to manipulate.

Indexed Universal Life (IUL) made a strong showing marketed by a particularly attractive story, if not altogether accurate.  Upside potential of the stock market without the downside risk sounded great with the memory of 2008 still fresh in minds.  These products can be illustrated at unrealistically high rates while appearing to be modest because few understood how they work.  Abuse is rampant even after the regulatory action of AG 49. For full post, click here…

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Q&A: Opinion of IUL Policies

May 24th, 2019 1 comment

Question:

I am curious as to your opinion of IUL policies? They seem to me to substantially overpromise, and they are too complicated for me to understand! Would love to hear what you think.

Answer:

Regarding IUL, I say “There’s not bad insurance as much as there is insurance done badly.” For full post, click here…

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The Tragedy of Group Term

April 30th, 2019 No comments
Steer clear unless it’s the only option.

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Understanding the Flaws in a Premium Financing Policy

April 16th, 2019 No comments
Convince a client without opening your mouth.

At the courthouse, the judge looked to the other guy and asked his story. After hearing the guy’s side, the judge ruled in my favor. I never opened my mouth. You can imagine how ridiculous the situation was when I didn’t even have to present my side of the story.

I’ve written at length about how little the typical consumer understands about premium financing. A part of my job has been to vet deals and fix problems. But even I was surprised earlier today when I had a scheduled phone call with a client who retained me to review his deal.

The phone call consisted of the insured individual, the premium finance guys, myself and my associate. In a way, the client was the judge, and respectively, the agent and I were the defendant and plaintiff, though I didn’t mean for it to be adversarial. That being said, I didn’t think it was a good idea for the client to move forward based on what I understood as his goals relative to what I was seeing. All I proposed to do was to bring objective information to the table. For full post, click here…

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Premium Financing is Great… Except When It Isn’t

April 10th, 2019 No comments

Digging into the numbers is exceedingly important.

More and more premium finance deals and proposals are making their way to my desk. Most have some common characteristics. First, they probably aren’t going to work, and second, consumers don’t understand them. When I say “don’t understand,” I don’t mean they simply don’t understand the details but that they have a misunderstanding of how the transactions will play out.

I’m a proponent of premium financing, when it’s done right and for the right reasons. Real-estate owners and developers have used OPM (other people’s money) very effectively because they’re often able to prove mathematically that the leverage makes sense. I’m doing the same thing when I don’t pay off my low interest home mortgage and keep my money in the market. However, when it comes to financing life insurance, I have an issue with much of what I see out there. First of all, I firmly believe that finance deals built around the arbitrage For full post, click here…

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Vetting a Premium Finance Deal

February 25th, 2019 No comments

A family office called me in to review and analyze a proposed premium finance deal. After gathering the details of what the family was trying to accomplish and requesting presentation materials, insurance ledgers and financing term sheets, I dove into it.

The advisors let me know that one of the primary things they wanted to understand was what their “bail out” option would be in 10 years. In other words, they wanted to understand their options in a worst case scenario, which is an important thing to get one’s arms around.

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This plan was built around a 10 pay whole life contract and the collateral for the policy was to be an existing whole life contract on the same individual, the matriarch of the family. A part of my analysis was a historic comparison of whole life dividend, and how they move in relation to the interest rate markets, to LIBOR rates. An important and revealing aspect of this for the advisors was how the policy dividends really work and how they are applied. For full post, click here…

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Is Association Term Insurance Really a Good Deal?

February 20th, 2019 No comments

Young professionals don’t stay young forever.

If your client is in his 20s and is a young lawyer, accountant, doctor or member of any association, he’s no doubt been offered the opportunity to purchase inexpensive term insurance through his association. He gets all the benefits of easy enrollment and no lengthy forms nor medical questionnaires to complete. He may not even have to pay a bill as everything might be done electronically through his payroll department. Then, to top it all off, he receives a dividend/refund check making the price even lower. He’s convinced association term life insurance is the best and only way he should ever buy term insurance for his family—after all, the members of his profession are clearly a better risk than the public at large. The only problem is those automatic five-year increases become very expensive once he hits age 40.

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Testing and Modeling Life Insurance by Bill Boersma & Marty Shenkman

February 12th, 2019 No comments

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