I had a mentor once who asked me a question to demonstrate a very important point. He said, “Charlie, what would your wife’s response be if you approached her and said ‘Honey, do you know that your face could stop a clock?’” I said, “Well, my wife’s reaction would likely not be a positive one.” He then said, “OK, conversely Charlie, what would happen if you went up to your wife and said, ‘Honey, do you know that when I look at you time stands still?’” I then said, “It would likely be a better outcome.” He said, “What I just said was the exact same thing, but I said it very differently. In our business it is not what you say, it is how you say it!
The above was something that has always stuck with me. We are certainly in an analytical business, but the best salespeople I have ever met were those that understood that we are also in a language business. The best salespeople in this business, whether wholesalers or agents, are those that don’t avoid discussing the complicated, but rather communicate the complicated in a simplified manner.
It is human nature for the brain to shut down when it is receiving an overdose of analytics. If you have been in this business for any significant period of time you have been in a meeting where you were force-fed analytics on a mass scale. In these situations, you can be faced with “analysis paralysis” where the brain puts up a wall and wants to do anything other than continue to listen to the presenter. Since much of what we do requires a great amount of analytics, discussing analytics can be hard for us to avoid. However, what if you could deliver those analytics past that wall the brain puts up via a Trojan Horse? What is the Trojan Horse I am referring to? What I am referring to is stories, analogies, metaphors and simplification. If you can wrap those analytics in the “Trojan Horse” of a story or an analogy, the critical information the client needs to know will be transported into the brain!
A perfect example of the analytics that are involved in our business is sitting right in front of me as I type this column. As I sit here I am looking at an indexed universal life (IUL) insurance illustration that is 39 pages long. The “Tabular Detail Ledger” is 14 columns wide. So why not make this illustration the topic of this month’s column?
To the untrained eye the details of an illustration can be very daunting to look at because…where does one start? It’s a very important stack of papers, but yet the risk of “analysis paralysis” is high when the agent or client looks at it. As the agent one may think, “Where do I start to explain the illustration? Do I discuss every single value, every single year? Why does one column increase while the other columns decrease? How are all of these numbers arrived at?” Etc.
We need to be able to explain this to our clients effectively. After all, the client signing this illustration is required by insurance regulations. I am a believer in disclosing everything, but I am also a believer in being able to explain everything in a simple manner so the client understands everything. To me, the last thing an agent needs is for the client to completely disregard those pages and sign the illustration because it is just too daunting. To my point, if you have taken out a mortgage lately did you read all of the documentation that you signed? I didn’t think so. So, over-disclosure and over-illustration can present a risk in that it can completely dissuade the client from even paying attention to the illustration—when the client would have otherwise paid attention if the illustration were shorter.
Clearly, I am not suggesting we do away with illustrations nor am I suggesting that you should not discuss the illustration. What I am suggesting is that it is important that the client not only signs the illustration, but also that he/she understands it! Granted, you are not going to make a non-numbers client an actuary in a conversation. But what if there was a roadmap as well as a method to explaining the illustration in a simple manner so the client can actually understand it? This may sound like a lofty task but it can be done.
Many times the most complicated illustrations can be those where the client wants to maximum fund the policy over X years, then take potentially tax-free loans out against the policy to supplement their retirement income. These types of illustrations are actually the most popular type that are run when IUL is being considered. As a matter of fact, Wink’s Sales and Market Report Q1 2017 reports that 78 percent of IUL is sold with the “Pricing Objective” of cash accumulation, versus other objectives like guaranteed death benefit, wealth transfer, etc. So using a scenario where accumulation, then loans, are illustrated, I want to focus on the “flow” in which you can explain the illustration in five key points, with the fifth point being discussed next month.
(Disclosure: The below demonstration is not all encompassing of the discussion of caps, spreads, expenses, etc. that should be incorporated into the agent’s conversation with the client.)
Scenario:
The scenario I would like to use is this: We have Jill, a 45-year-old female in good health, who has a life insurance need of $500,000. She wants to maximum fund this policy because 20 years from now at retirement she would like to begin taking loans against the policy as retirement income. We will assume a six percent illustration rate and solve for a “Fixed/Wash Loan” amount that can be taken against the policy from age 65 until age 100. In this scenario we chose an increasing death benefit (Option 2 Death Benefit) switching to level (Option 1) after the premiums are paid. This death benefit option will allow more premium to be paid into the policy versus a level death benefit. What this does is it decreases the net amount at risk (death benefit minus cash value) in the policy which, in turn, reduces the cost of insurance charges.
(Note: Although I am starting with a death benefit in mind in this example, many times the illustrations are done with the starting point as the premium amount that the client wants to put in and the illustration solving for lowest death benefit. In both cases the below points would apply.)
Illustration Point #1: The Seed
If the IUL is designed properly, one of the benefits of those retirement distributions (loans) are that they are potentially tax free to the client. Yes, the premium you put into the policy has already been taxed but if the policy is set up correctly, the distributions are not. I like to say that with IUL, you are paying taxes on the seed, but not always on the harvest. The first point on the illustration is to point out what the premium/seed is going into the policy—not just the annual premium/seed, but the total of those 20 premiums. In this scenario Jill would be putting in $17,922 per year, or $358,440 over the 20-year period until age 65. This is the first point on the illustration to emphasize. What can Jill get in return for that “seed” of $358,440?
Illustration Point #2: The Potential Harvest at Retirement
The second crucial point on the illustration is the year in which she would like to retire, which is typically age 65. In this year you want to discuss a couple different points:
Death Benefit: What does the death benefit look like in that year of retirement, before the loans begin to come out? In this scenario Jill’s death benefit has increased to a little more than $1.1 million. This is a point that presents an opportunity to discuss why you illustrated an increasing death benefit—the fact that it decreases internal expenses in the policy and it also offers the ability for the death benefit to offset inflation.
Surrender Value: At age 65 Jill’s surrender value is $621,700. This warrants a discussion around the fact that she put in a “seed” of $358,440 and is able to, at that time, take out a harvest” of $621,700. That is, assuming the illustration is 100% accurate, which it never will be. This is where you discuss the fact that the illustration was assuming six percent, which is merely a projection and not guaranteed. A conversation around the “guaranteed values” is important at this time.
As you discuss the “projected” $621,700 in surrender value in that retirement year, you can tell Jill at that point that she could request that money to be sent to her and the insurance company will send her a check. She could cash out that entire $621,700! However, the check is not the only thing the insurance company will send out in this scenario. They will also send out a 1099 for the difference between what she put in (basis) and what she took out. Any time a life insurance policy dies before the client dies, it is taxed like an annuity! Thus, she would get a tax bill on $263,260 ($621,700 —$358,440) in income. Clearly, we do not want this. So this is where you tell Jill how she can get access to that “harvest” without the 1099 coming. This is where you move on to point #3.
Illustration Point #3: The Loan Amount
In the first year of retirement for Jill (Age 66) she can take loans against the policy of $41,143 in this example. As you point this number out you want to explain two different things to Jill:
Again, the loan is typically not taxable. Why not? Because loans generally are not taxable! When she goes to the bank to get a mortgage or a loan, those transactions are not taxable to Jill, correct? This situation is no different, assuming it is a non-MEC contract of course!
You projected the loans to run until age 100. If she wanted the loans illustrated longer, age 120 for example, you can run it that way as well.
When I am training agents I like to point something else out: Have you ever been asked by the client, “Why do I have to take a loan from myself? That is my money I am taking out!” Here is my explanation:
The client is not taking anything out of their policy. What is happening is the client is going to the insurance company and the insurance company is making a loan to the client; in this example to the tune of $41,143 per year. These loans are not much different than Wells Fargo giving the client a loan. However, how does the insurance company guarantee they would get their loans plus interest back should the client die or surrender the policy? This is where the insurance company collateralizes the surrender value and the death benefit of the client’s policy year by year as those annual loans are taken. The ability for the insurance company to do this is great because the loans, plus interest, are fully protected by the policy. This is why you see the “Surrender Value” and “Death Benefit” columns on the illustration decreasing once loans are taken, not because money has been taken out of the policy, but because a portion of the death benefit is being used as collateral! Furthermore, this is also why the accumulation value, also known as cash value, is not decreasing—because the client did not take one penny of their cash value out of the policy. The client merely got a loan from the insurance company and the insurance company used the surrender value and death benefit as collateral. Again, on the illustration the accumulation value usually continues to grow while the surrender value and death benefit decrease.
Illustration Point #4: Life Expectancy
Although Jill, as a 45-year-old female, has a life expectancy of 82 (per the Social Security Tables), I will generally use the next five-year increment because of the fact that insurance company illustrations usually sum up the premiums and loan amounts in five-year increments. Thus, in the example using Jill, I will have a discussion around the numbers at age 85.
This is where I will reemphasize the fact that she would be putting in a “seed” of $358,440, but in exchange for that “seed” she would be allowed total loans over her lifetime that add up to $822,860 ($41,143 X 20 years) that will not be taxed. Again, the illustrations will generally add these numbers up for you in 5 year increments. I then point out that the $822,860 was not the total “harvest” the policy would have generated. Why not? Because if she happened to pass away in that year there is also a death benefit that is passed on to the beneficiaries that is tax free. The death benefit in this scenario is $507,727. In this scenario there is a total “harvest” generated from the insurance policy of $1,330,587 (total loans + death benefit) versus a “seed” of $358,440. Again, this is based off the projection of six percent, which is just that—a projection.
At this point in time, especially if the client is more on the analytical side, the client may want to discuss the costs in the policy. In other words, is putting in $358,440 into something that generates a value of $1,330,587 40 years later a good value? Unless the client is savvy with the cash flow functions in a financial calculator, that can be hard for them to quantify. This is where I like to utilize the Internal Rate of Return Report that usually can be included in the insurance company’s illustration. To me, these reports are invaluable when it comes to quantifying the value of the policy, and also in quantifying the expenses embedded in the policy.
This fifth point, Internal Rate of Return Report, warrants its own column and is “to be continued” next month.
Neither North American nor its agents give tax advice. Please advise your customers to consult with and rely on a qualified legal or tax advisor before entering into or paying additional premiums with respect to such arrangements.
Indexed Universal Life Insurance products are not an investment in the “market” or in the applicable index and are subject to all policy fees and charges normally associated with most universal life insurance.
The opinions and ideas expressed by Charles Gipple are his own and not necessarily those of North American or its affiliates. North American does not endorse or promote these opinions and ideas nor does the company or agents give tax advice. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed as to accuracy. All presentations are for agent representative use only and cannot be used, in whole or part, with consumers.
Income and growth on accumulated cash values is generally taxable only upon withdrawal. Adverse tax consequences may result if withdrawals exceed premiums paid into the policy. Withdrawals or surrenders made during a Surrender Charge period will be subject to surrender charges and may reduce the ultimate death benefit and cash value. Surrender charges vary by product, issue age, sex, underwriting class, and policy year.
For most policies, withdrawals are free from federal income tax to the extent of the investment in the contract, and policy loans are also tax-free so long as the policy does not terminate before the death of the insured. However, if the policy is a Modified Endowment Contract (MEC), a withdrawal or policy loan may be taxable upon receipt. Further, unpaid loan interest on a MEC may be taxable. A MEC is a contract received in exchange for a MEC or for which premiums paid during a seven-year testing period exceed prescribed premium limits (7-pay premiums).
The net cost of a variable interest rate loan could be negative if the credits earned are greater than the interest charged. The net cost of the loan could also be larger than under standard policy loans if the amount credited is less than the interest charged. In the extreme example, the amount credited could be zero and the net cost of the loan would equal the maximum interest rate charged on variable interest loans. In brief, Variable Interest Rate Loans have more uncertainty than Standard Policy Loans in both the interest rate charged and the interest rate credited.
The information presented is hypothetical and not intended to project or predict investment results.
