Tags: client acquisition | financial planning | investing | new investors | retirement planning

Nearly 60% of Americans born between 1965 and 1989 are making automatic contributions toward their retirement savings,compared to 46% of non-retired Baby Boomers born between 1946 and 1964. In addition, the younger generations that followed Boomers start saving for retirement, on average, in their mid- to late-twenties, nearly a decade earlier than Boomers, according to a survey released by TD Ameritrade.

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Tags: Advisor businesses | client education | retirement planning

Suppose you receive a $1,000 dividend on your whole life policy. How was that determined? Why wasn’t it $1,100 or $900? How can you be sure that $1,000 is what you should be receiving?

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I recently reviewed whole life illustrations from two companies for two clients. My clients wanted to stop paying premiums after 10 years, so I requested pairs of illustrations for premium-offset versus reduced paid-up scenarios to test a conjecture. With premium offset, you use dividends and accumulated paid-up additions to pay premiums. If you elect the reduced paid-up option, premiums cease under the terms of the contract. Premiums include loading for commissions and state premium tax, so it seems reasonable to expect that the reduced paid-up option should be more efficient than premium offset.

For one company, that was indeed true; if you wanted to stop making out-of-pocket payments after 10 years, you would have higher death benefits and cash values if you elected the reduced paid-up option. For the other company, however, you were worse off with the reduced paid-up option; the illustrations showed that dividends were lower if you elected that option.

I asked an actuary at the second company for an explanation, and I received this reply:

“All non-guaranteed values are a function of current illustrated dividend scale interest rate. While the values are higher for the premium-offset in this example, the results will vary from case to case. Keep in mind that, as part of the normal annual dividend scale cycle, we reserve the right to change any component of the dividend scale which could lead to varying results for this comparison.

There generally is an advantage in paid-up versus premium-offset, but that is not the case across the board. The dividend scale components are proprietary, but I can tell you that there are different factors used on paid-up versus premium-offset.”

Joseph M. Belth, a distinguished insurance professor, publishes The Insurance Forum. From the first issue in January 1974 (“Pity the Old Policyholders”), he has been raising questions about dividend calculations and advocating more disclosure. In the March 2008 issue, he reported on his investigation of the dividend calculation for his own whole life policy. His conclusion:

“Banks disclose savings account interest calculations, and life insurance companies should disclose dividend calculations. However, companies are reluctant to reveal the information voluntarily because they fear doing so would place them at a disadvantage if their competitors do not take a similar action.

State insurance regulators are responsible for the confidentiality that surrounds the determination of life insurance dividends. I believe that the regulators should require companies to make their dividend methodologies available to the public.”

While you wait for insurance regulators to act, you can get more information about dividends from these sources:

- “Policyholder Dividends and Nonguaranteed Elements in the U.S. and Canada,” Professional Actuarial Specialty Guide, Society of Actuaries, 3/1/1997. This contains an overview and an annotated bibliography.

- Company handouts. Some companies provide a brief explanation of how dividends are determined, including examples showing the interest, mortality and expense components. Agents may receive a more detailed explanation prepared by the chief actuary.

- Company responses to the Exhibit 5 interrogatories of the statutory annual statement. The questions address the dividend determination process, experience factors, the impact of policy loans on dividends, and the sustainability of the current dividend scale. The quality of company responses varies from perfunctory to informative.

- Nadine Gatzert, Ines Holzmüller and Hato Schmeiser, “Creating Customer Value in Participating Life Insurance,” Journal of Risk and Insurance, September 2012. This will introduce you to the economic literature on participating policies, although most of this research relates to European policy designs.

Stepping back, why should you even consider putting money into life insurance policies that suffer from such a lack of transparency?

Whole life insurance has several things going for it:

- Many whole life insurance policies have term and paid-up additions riders that let you use blended designs to reduce the agent’s commission and improve the policyholder’s values. You can sometimes do this with universal life policies, but it is not as common.

- The option to use dividends to buy paid-up additions provides an easy way to create an increasing death benefit, which can reduce the risk that the life insurance policy will provide less money for heirs than investing the premiums elsewhere. Universal life also provides an increasing death benefit option, but the growth rate is generally slower and it is more likely to fail at later ages.

- Whole life insurers provide investment services that are underappreciated. Insurance company general accounts contain some investments, such as commercial mortgage loans and private placement bonds, that are generally not available to retail investors, and investment expenses are typically less than 0.25%. The inevitable volatility of investment returns is smoothed by the dividend determination process; gains and losses may be amortized over five years or more. These investment services may be similar for traditional universal life (although the beneficial effect may be smaller), but not for indexed or variable universal life.

- Lack of transparency makes whole life easier for insurers to price and manage, especially in a low interest rate environment. Whole life policies have hidden front-end and ongoing charges that create a more efficient match between expenses and charges; if these charges were disclosed, they might be rejected by consumers who do not understand their rationale.

The opacity of dividend formulas allows insurers to offset negative interest components (which can occur when the insurer is earning less than the guaranteed interest rate) against positive mortality components, whereas the unbundled design of universal life forces insurers to raise cost-of-insurance rates or accept a loss.

- Whole life has less premium flexibility. I’m usually inclined to say that more flexibility is better than less, but flexibility has costs as well as benefits. It is easier for people to get into trouble with universal life because there are no immediate negative consequences for not paying a premium; in most cases, the policy will stay in force as long as there is enough money in it to cover the monthly charges. In contrast, not paying a whole life premium leads to lapse or a policy loan.

Premium flexibility also increases the insurer’s uncertainty about its cash flows, and it can lead to adverse selection with regard to investment returns (policyholders can time their premiums to take advantage of above-market returns) and mortality (policyholders can time their premiums to take advantage of new information about health).

On the other hand, the lack of premium flexibility makes it harder to sell whole life policies in the secondary market for an attractive price.

- Judging from the policies that my fee-only colleagues and I see, whole life has performed better over time than universal life. Perhaps this reflects inherent pricing advantages in the whole life design or the fact that whole life policies are mostly issued by mutual companies. If I had to place a bet on long-term performance, measured in some reasonable way, I would bet on whole life.

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We store 100% of our mind maps in the cloud.  We use Rackspace as our cloud solution.

Q: Are your mind maps tied in to your CRM? Shouldn’t they be?

• Pre-boomer (born before 1945): This group is also known as the “traditional” or “silent” generation.  They tend to be attracted to name brand recognition, credentials, past performance and like to interact with their advisors on a social basis (i.e. golf, dinner and gentlemen’s clubs).  They like to communicate by phone and in person meetings.  By and large the husband (if a married couple) is the one who most often comes to meetings and makes the decisions.
   
• Boomers (born 1946-1965):  This is the first “we to me” generation.  They tend to be optimistic if not idealistic, forever young, over achievers and engaged in life.  Watch the financial commercials on TV.  This is a fun generation to serve!  Most meetings, its husbands and wives equally engaged in the planning process and the mind map resonates with them well.  They want custom creative solutions uniquely tailored to their personal objectives.  One of their most precious commodities is their time.  They are less likely to want to be wined and dined by their advisors.  Most interactions are done in person or phone.  However, we have several boomer clients who are very comfortable in doing video meetings.
   
• Generation X (born 1966-1979):  This is my generation!  We love to stalk goods and services online for hours then swoop in to make our purchase or hire an advisor.  We also tend to be more pessimistic than the Boomers.  We know things do not go according to plan.  For example, one of my earliest memories was watching Richard Nixon resign.  We also take and give referrals to our peers since they also are online predatory stalkers.  We demand total transparency, do not want to be sold, and crave lots of information before making a decision.  We like to communicate primary via email and tend to be very comfortable with web meetings; in fact, it’s almost preferred.
   
• Generation Y (born 1980-1999): This is also known as the “special generation.”  They are the offspring of the Boomers.  They are called special because they have been told for their entire life that they are special by their parents.  They are friends with mom and dad.  They receive 9^th place trophies.  This special group of people is pack creatures; they go to prom in groups.  They like to by the same products and services as their friends but with a unique twist.  The primary method of communication is texting.  Their view of work is far different than their parents.  A good way to meet an affluent Boomer is by serving their children.