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Letters Of Explanation – Policy Funding Options

September 24th, 2018 Leave a comment Go to comments

Dear Mr. Client:

It was a pleasure to speak with you last week and I appreciate the opportunity to review your life insurance policy. Per our discussion, this note is intended to be a follow up summary of our conversation. If there is any additional information you were looking for which I have forgotten to include, or if you have questions about what I have written, please do not hesitate to get back with me.

Your $1,000,000 was originally an Alexander Hamilton policy which was acquired by Jefferson Pilot and subsequently merged with Lincoln Financial. Though I do not have the original sales ledgers, the original premium of $13,750 was likely calculated to maintain the policy indefinitely given the interest crediting and expenses assumption in play at the time the policy was issued in 1995.

Since that time interest rates have come down significantly; probably 300 basis points or more.

Similar to any traditional investment, if this contract does not received the assumed crediting rate, it will not perform as expected. Whether or not you realized that back in 1995 is beyond my understanding.

I ordered four different in-force ledgers:

  1. no premiums
  2. restarting the original $13,750 annual premium
  3. calculating the necessary annual premium for the policy to last to age 100 of the younger insured
  4. calculating the necessary annual premium for the policy to last beyond age 100 of the younger insured

I then took the numbers from these projections and put together a table which I have attached to this email. This table distills the economic performance of the policy to a traditional investment by running some time value of money calculations. In other words, what is your rate of return on cash value and ongoing premiums to future death benefit? Remember that I have to assume premiums paid to date are water over the dam. I am starting with your “cut and run” number of the $306,000 current cash value as present value (PV). I assumed various payments (PMT) as indicated above. Future value (FV) is the death benefit and ’N’ is the number of years to death of the survivor.

As an example, if you were to put $13,750 a year into this policy moving forward and the survivor of you and your wife passed away in 8 years, the rate of return of this “investment” would be 12.81% net. However, without increasing the premiums, if one of you lived 2 years longer than that, 10 years from today, the policy would collapse and pay no death benefit.

We discussed that one way to look at this is to decide if you are willing to defer $306,000 for $1,000,000 down the road? The risk is that if you live “too long” you may outlive the policy or you may be forced to put significantly more premiums into it to make it last.

Based on our conversation you decided to restart the $13,750 annual premium and we will re-evaluate this transaction in two years. Given the fact the crediting rate of this contract is already at the minimum rate, it would normally seem rather soon to re-evaluate, however, there have recently been some insurance companies that have increased the internal mortality charges of the contract even though there has not been an increase in mortality experience. Lincoln is one of those companies. Rightly or wrongly, they are trying to reduce portfolio pressures due to a sustained low interest rate environment.

I have had other clients suffer this consequence. Per my evaluation, it does not appear your contract is currently subject to increased expenses.

Finally, I have been asked about the recommendations for managing this contract that you received a few years ago. Since I was not there and did not interact with the consultant it is difficult to make concrete commentary but I was provided a copy of the analysis. While I understand exactly what he did and how he came to his conclusion, I do not agree with it. Sometimes being “actuarially prudent” is in the eyes of the beholder. Though it is somewhat a cliché, this is as much art as it is a science. Though I don’t necessarily disagree with his actuarial analysis, I would have done it differently as the repercussions of being wrong are disproportionately egregious relative to the benefits of being right, in my opinion.

Once again, thank you for the opportunity and I look forward to speaking again. Please enjoy your day.

Bill

 

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