I have been running illustrations for a LONG TIME, and I learned very early on how IMPORTANT it is to include the Internal Rate of Return (IRR) report in any illustration. Advisors AND clients like to see the IRR calculations on the illustrations because they are very helpful when evaluating comparative cash flows on the asset class that is life insurance. These reports are so important to the advisor and client evaluation that AgencyONE works up an excel spreadsheet to create the needed IRR values if the carrier software does not offer the reports.
How a Death Benefit IRR is Calculated
A Death Benefit IRR is calculated by comparing the cumulative premiums (cash flow out) against the death benefit payout (cash flow in) in an assumed year of death. The premiums paid for a life insurance policy becomes the negative cash flow and the death benefit payout becomes the positive cash flow. It helps to have a ballpark client life expectancy to calculate the IRR based on a projected date of death and not just to age 100.
How to Improve an IRR
One way to improve an IRR is to pay a LOWER PREMIUM into a specified death benefit. BUT there is an issue with this option. By under paying the premium the policy may not make it to the targeted life expectancy or to age 100. This plan immediately hurts the policy design. The BETTER way to improve the IRR towards life expectancy is to pay MORE premium into the initial face amount but make a small design tweak to the death benefit option. Who remembers using Return of Premium Death Benefit (ROP) options to improve IRR percentages towards maturity? These death benefit options are sometimes referred to as Death Benefit Option 3 or DB Option C. This option increases the initial death benefit in the amount of the premium paid. ROP is similar to a death benefit that increases by the cash value, but it will always net the client the initial death benefit of the policy.
Do Not Be Confused
This ROP death benefit is not to be confused with products that return client’s premium payments on policy surrender in specific policy years. The ROP death benefit option has a few design and underwriting rules:
- Some carriers limit the products available.
- The max face amount may be a multiple of the initial face (2-3x initial face) so, on certain premium designs, the increased face may stop at a certain point while premiums are still required to keep the coverage inforce.
- Carriers consider the face amount projected at age 100 and NOT the initial face amount during underwriting for the requirements.
To clarify, if the initial face amount is $1,000,000 but it grows to a $1,743,000 death benefit by age 100, the carrier obtains requirements and underwrites based on the $1.74 million face amount.
IRR’s & How They Can Change
AgencyONE had a case involving a Male, age 62, who was a Preferred rating and wanted a $1,000,000 death benefit. I used a standard LE of 21 years (age 83) and a Current Assumption Universal Life product.
There is not much of an improvement on the IRR’s at LE assuming we start at $1,000,000 of death benefit. BUT what if we build this differently to reach $1,000,000 at life expectancy by purchasing less death benefit now? The following scenario assumes we start with a death benefit of $675,000 and add the ROP death benefit option. The client pays a lower premium which will build the death benefit to the desired $1,000,000 at his life expectancy. With this scenario, the client saves $836.00 per year in premium and sees small increases in the IRRs at LE and beyond.
Another Competitive Option – Survivorship
Let’s look at another competitive option using a survivorship policy that provides a guaranteed death benefit to age 100. Both clients are assumed at age 62 and Preferred NT.
The SUL product shows an interesting comparison at these ages. The level pay option makes the most sense and if the clients decide on second-to-die coverage they can pay the lowest premium overall. I used the same ROP strategy to see how it compares but the premium difference is not as compelling. Most agents and clients, in my opinion, will just buy the $1,000,000 level amount.
As you know SUL coverage has numerous age and UW combinations. Maybe the age 62 cells are not as compelling, but what if we look at two clients who are 72 years old and do the same comparison. I am targeting $1,000,000 of coverage at age 90.
The ROP death benefit design saves the client about $1,286 per year in premium for GUARANTEED coverage.
AgencyONE has the necessary knowledge and tools to help our advisors provide the BEST OPTIONS for their clients’ financial planning needs.