The True Meaning of the S&P 500 Index

July 19th, 2017 No comments

DECK: It may not be what you think

Have you ever heard something often enough that you take it for fact but you don’t really under-stand what it means? What if I told you the S&P 500 Index wasn’t really what you thought it was? Would you believe me versus everything you ever understood it to be? Probably not.

The total return of the S&P 500 and the S&P 500 Index are meaningfully different things. The S&P 500 total return is what you likely understand it to be; the actual return you would experience if you held the stocks that constitute the S&P 500. The S&P 500 Index, on the other hand, doesn’t include dividends. One can’t directly invest in the S&P 500 Index. I bring this up as it relates to indexed universal life insurance, the fast growing sector of the life insurance market and the “product of the day.” I don’t think it’s a bad product, it just needs some ‘splaining.

The Difference

So there’s a difference. What does it mean? When you think of the long-term return of the S&P 500, what comes to mind? Most people think double digits, somewhere between 10 percent and 11 percent today, maybe down a hundred or so basis points from the general understanding be-fore the Great Recession. They would be right. What about the S&P 500 Index? Substantively different.

There are some calculators on line that allow you to put in any range of dates to receive multiple pieces of data, including, the annualized return with and without dividends. I had some fun put-ting many date ranges in to see what came back.

But first, why do I care? Why would you, as an advisor, care? Because almost none of your clients understand how the fundamental difference between the total return and the index is instrumental to the funding and eventual success of their Index contracts.

The AG 49 regulations last year limited the projected interest rates carriers could use in their life insurance sales ledgers. The high projected rates were a bit silly, and the regulations reined that in a bit. The actual rates that can be used are a factor of how a particular product is built but generally fall in a range from the high fives to low sevens. This sounds pretty reasonable when considering a double-digit long-term return in the markets, doesn’t it? There’s more to the story.

The Calculator

Back to the calculator. I ran calculations for multiple time frames over many decades. For ex-ample, I ran 1920 to present, 1930 to present and every 10 years through 2010 to present. I ran 10 and 20 and 30 year periods starting at various places through history; scores of ranges.

It was fascinating. When I looked at total returns from various dates to today (1920 to 2017, 1930 to 2017, etc) every range was nine, 10, 11 or 12 point something except for 2000 to 2017, which was 4.75 percent. Seventeen years at 4.75 percent, including the most recent bull market? That’s a bit sobering. However, the S&P 500 Index showed a meaningfully different story. No “from then to today” duration except 2010 to 2017 ever hit double digits. You can’t really count 2010 to 2017, which starts at the end of a historic market crash and primarily only measures a bull market.

Looking at some other durations, there were some heady times. The years from 1980 to 1990 were 11.85 percent (16.63 percent total return). The years from 1980 to 2000 were 13.62 per-cent (17.43%). But 1980 to 2010 was back down to 8.02 percent and 1980 to 2017 is 8.51 per-cent. The years from 1960 to 1980 were only 3.29% and those from 1970 to 1980 were only 2.08 percent. You add the 1970s to the high flying 1980s and 1990s, and you’re back below 10 percent. The bottom line is that hundreds of basis points of return are chopped off before getting to the return that’s called the S&P 500 Index.

Over the durations, dividends accounted for roughly 20 percent to 40 percent of the total S&P 500 stock market return. From 2000 to 2017, it’s 41 percent. Between 1970 and 1980, dividends are 66.7 percent of the return. Between 2000 and 2017, they’re 41.3 percent. These percentages account for a large portion of the return.

The Disconnect

Clients are hearing one thing while something substantively different is happening. If a client is being proposed a policy that assumes 6.28 percent (real life case recently) and believe this is off of the 1980 to 2017 total return of 11.42 percent, they would feel much more comfortable than if they realized it was really off of an 8.51 percent return without dividends. From 1930 to 2017, that number is 5.49 percent, less than the assumed crediting before any expenses.

All of this is before the expenses the insurance company must incur to buy the options to credit the policies in the up years. This is necessary because your clients’ premium dollars aren’t actually being invested in the Index, they’re going into the general account of the insurance company. Given the exceeding modest rate the carriers are getting on their investments nowadays and that they have to spend some of that money on buying options, well, the expense ratios of these contracts can get pretty steep before even looking at mortality costs, commissions and running a company.

If your clients understood this, would they be a bit more conservative concerning the assumptions on which these products are being constructed? Also, remember that these historical rates are primarily based on performance from a time with significantly higher risk free interest rates.

AG 49 Regs

Are the AG 49 regulations helping? Sure, they’re helping, but they aren’t a failsafe. The 6.28 percent rate isn’t being shown because it’s conservative; it’s being shown because it’s the regulatory maximum that can be shown. Additionally, it’s cherry picked as the best illustratable return of multiple potential Index calculations the carrier offers. Just because one CAN show 6.28 per-cent doesn’t mean one SHOULD show 6.28 percent. That’s like saying one should run variable life proposals assuming 12 percent because that’s what the regs allow. That would be insane.

Other Considerations

What else is there to consider? Sequencing of returns! Linear returns and dynamic, real life re-turns are dramatically different. In other words, it’s not just WHAT returns one gets, it’s WHEN they get them. There’s independent modeling available that randomizes returns as a Monte Car-lo simulation would to see how a proposal would fair in a more real life scenario. The results aren’t pretty. A sales ledger that looks responsibly funded has an insanely high chance of falling apart given more realistic sequencing of market returns. It’s important to realize that the every day sales ledger, from which your client is making decisions, isn’t even a remote possibility. What’s being used is a sales tool that’s only capable of showing something that’s a statistical impossibility.

Additionally, the expense structures of these contracts affects performance dramatically. Need proof, try stress testing a contract by changing assumed crediting rates, even minutely. What you may discover with contracts that use an Indexed product to look competitive is that an infinitesimal change in assumptions can have a devastating effect on the sustainability of a policy.

Rate Translator

One insurance company I know of has a “rate translator” available. This is a tool they offer for agents, advisors and consumers to use for determining a realistic crediting rate in their illustration software given an expected market return. In this situation, I actually like the fact the proposed policy and the tool are with the same carrier, not an independent organization because when we’re looking at the 6.28percent crediting rate, that very carrier’s own tool calculates that to use 6.28 percent, one must assume a 10.15 percent long-term equities return. How many of your clients are comfortable assuming this? Is there any other part of their portfolio they would be willing to invest this aggressively when they are 70, 80 or 90 years old?

The translator’s 25-year look back rate is only 6.79 percent. Who’s willing to assume future re-turns 336 basis points greater than the average of the past 25 years?

One last thing for now, the translator needs an input for guaranteed minimum crediting, which is 0 percent in this case, and a cap, which is currently 10.5 percent. However, that cap isn’t guaranteed. The only guarantee is the cap can’t go below 3 percent. If I change the cap in the translator from 10.5 percent to only 10percent, the required equity return goes to 11.1 percent. When I input a 9 percent cap, the translator wouldn’t allow me to assume a rate high enough to warrant a 6.28 percent crediting rate because it’s is limited to a 12 percent equities return.

Why does this matter? The cap rates have been coming down. As difficult as it is to justify the rates being used today, if the cap rates continue to come down modestly it would necessitate an equities return that’s realistically unfathomable.

The cherry on top of all of this?  Even though all the data points to eventual failure and disappointment, there is one last thing which may be the nail in the coffin.  I have a favorite line which goes “Marketing follows recent experience”.   Auto companies marketing hybrids when gas prices are high is a classic example.  The life insurance industry plays into this perfectly.  With every change in the financial markets, a new product is rolled out to take advantage of it.  This isn’t always bad but it can certainly be abused.  When consumers are disappointed with one experience, market a new one.  Unfortunately with emotion calling the shots, the new experience often ends up in disappointment as well.

Ever hear of buying high and selling low?  Isn’t that the epitome of emotional and/or uneducated consumers potentially manipulated by opportunistic and/or uneducated sales people?  The nail in the coffin is that policy owners buying equity associated contracts today are going in at the top of the market.  The statistics and modeling predict failure even if this wasn’t the case but being so far in to a bull market and at or near record stock market levels, entering an equities type transaction meaningfully adds to the risk of these products working as expected.

In a subsequent post I will relate the real life effects on an actual proposed contract.


Categories: Life Insurance Tags:

Is Term Insurance a Commodity?

July 13th, 2017 No comments

Hopefully the message that life insurance cannot be treated as a commodity is slowly getting through to advisors and consumers. I see signs here and there that it is but it seems to be a painfully slow process.

Even when that realization sets in, the perception of term insurance is often different. I have to admit that I haven’t always viewed the details of term insurance on par with permanent insurance but there are aspects to keep in mind which may not surface for years to come. For full post, click here…

Categories: Life Insurance Tags:

AALU Piece: Avoiding 5 Common Mistakes in Life Insurance Planning

June 15th, 2017 No comments
TOPIC: “Trouble Ahead, Trouble Behind,” and You Know that Notion Never Crossed My Mind: Avoiding 5 Common Mistakes in Life Insurance Planning.

As estate planning involving personal life insurance becomes commoditized, so does the chance that a minor oversight will have a major tax impact.

SYNOPSIS: According to experts, some of the most common mistakes in life insurance planning include: (1) failure to qualify gifts to irrevocable life insurance trust (“ILITs”) for the annual gift tax exclusion; (2) improper allocation of GST tax exemption to ILIT gifts; (3) retention of incidents of ownership in an ILIT – owned policy; (4) failure to understand the planning implications of a policy classification as a modified endowment contract; and (5) triggering tax on an otherwise non – taxable policy exchange under Internal Revenue Code (“Code”) §1035. Find out how to identify and avoid them. For full post, click here…

Categories: Life Insurance Tags:

OC Consulting Group – What’s it about?

May 23rd, 2017 No comments

Categories: Life Insurance Tags:

Timing of Premium Payments

May 11th, 2017 No comments

AIn my May 12th, 2015 post, Why Paying Attention is Important, I referenced a hypothetical issue which has just come across my desk in real life. It has to do with a Guaranteed Universal Life (GUL) policy and the timing of premiums.

Much has been made of the sensitivity of GUL contracts to the timing of premiums, and for good reason.success-stories-logo Many policies do not have the grace periods of more traditional policies. A premium which comes in late, may slightly affect the internal formulas which determine the guarantees and, consequently, the policy may not last as long as expected. For full post, click here…

Categories: Success Stories Tags:

Insurance By The Numbers

May 4th, 2017 No comments

Help Your Clients Understand What They Are Really Getting For Their Money

Have you ever been talking with someone intelligent who says something which makes you do a double take? I’m talking about the kind of thing which makes you assume you have misheard them because no one could really think that.

Here’s a case in point I often hear in reference to funding a traditional whole life policy. “I keep paying the premium, even though I don’t have to, because it grows the cash value so much.” What’s so crazy about this comment? For full post, click here…

Categories: Life Insurance Tags:

Success Story: Life Settlement Saves the Day

April 18th, 2017 No comments

The life settlement market is clearly much different than it was 10 years ago but it is still alive and well. The target for finding a qualifying policy is much smaller today but the parameters were likely somewhat unrealistic back then anyway.

Settlements still tend to be success-stories-logosomewhat controversial but with a straight face I will say that I cannot understand why. A legitimate, well understood life settlement is arguably the most consumer beneficial concept I have ever been a part of in my history in the life insurance market. The many, many millions of dollars I have been able to secure for clients who otherwise would have lost millions is astounding. For full post, click here…

Categories: Success Stories Tags:

Giving a Life Insurance Policy to Charity

April 11th, 2017 No comments

Over the past number of months I’ve had a handful of cases come across my desk involving life insurance and charity. As is so often the case, some of the transactions ended up as case stud-ies in what to watch out for.

I understand that not everyone is going to have the same attitude regarding the intersection of life insurance and the non-profit sector but I am somewhat surprised at the black and white policies of charitable organizations I encounter at times. Many charities and non-profits have a policy to simply cash out life insurance policies which are donated. I can’t think of a more short sighted stance. Of course each and every transaction should be evaluated on it’s own merits relative to required premiums, guarantees, life expectancy, use of money, etc. It also doesn’t help that so many non-profits have been burned by life insurance over the years the same as so many consumers have. For full post, click here…

Categories: Life Insurance Tags:

Managing Life Insurance Like a Pro

March 6th, 2017 No comments

I often talk about “managing life insurance” and advisors occasionally ask me what that means or looks like. Fair question. There are multiple ways to manage life insurance, depending on what type of contract we’re talking about. Today I have a very simplistic and obvious example which is often overlooked.

The bottom line idea behind managing life insurance is the same as managing anything. To manage something is to handle it in a certain way, typically to improve results. We all try to improve the results of financial transactions by managing them, or hiring professionals to manage them, appropriately. For full post, click here…

Categories: Life Insurance Tags:

Always Say Never

February 7th, 2017 No comments

Sometimes dealing with the details of life insurance can be overwhelming for professionals who lack expertise in this particular market. I’ve written over and over again that it is more complex than most people realize. I can talk until I’m blue in the face about bringing this up for conversation while highlighting the dramatic mutual benefit to advisors and their clients. Only a minority will get on board.

I can’t give up on trying to urge advisors to do something which is so easy and so benign that they won’t fight it; something with such an outsized benefit that it would be silly not to layer it into every conversation. I think I have settled on something with a threshold so low it is a non-issue. For full post, click here…

Categories: Life Insurance Tags: