The Insurance Illustration Landscape is changing

Should You Believe Insurance Company Illustrations?

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Jim Lorenzen, CFP®, AIF®

Just in case you haven’t heard, Genworth has decided to suspend life insurance and annuity sales.   This decision will leave many agents and their client with questions on where to turn and how to get protected.

Insurance companies seldom discontinue a business segment when it’s either profitable or if they haven’t overextended themselves.  Remember Executive Life?

Before Executive Life of New York went under, they had over 50% of their portfolio invested in less than investment grade ‘junk’ bonds, despite the fact that in June 1987, the New York legislature had mandated that insurance companies licensed to business in that state were to limit their general portfolios to no more than a 20% allocation to such bonds.  Remember, there are no guarantees; there are only guarantors. [Source:  The New Insurance Investment Advisor, Ben G. Baldwin, McGraw-Hill 2002, p. 37.].

A qualified advisor would/should have looked “under the hood” at the company’s investment asset allocation and quickly realized it wouldn’t be used in a client’s portfolio; so, why would anyone use it to back their retirement or legacy planning?  Unfortunately, as all too often happens, insurance companies can take ill-advised risk in order to promote unrealistic return rates to pump-up sales.

Life insurance illustrations have had, for more years than I can count, a well-deserved reputation for less than transparent and amazingly inaccurate projections of what the policyholder could expect in future years.   The unfortunate result is that one of the most amazing financial products on earth – and life insurance does far more than most people even suspect – has suffered from a plethora of negative bias, both in and outside the media universe, and virtually all of it wrong.

A regulatory solution?

A recent regulatory change recently took affect that limits the growth rate an insurance company can use in its illustrations to a maximum that’s based on the company’s current ‘cap’ rate applied to an average rate history going back over 50 years.   The key is that the company can use its current cap – which actually can function as an incentive to keep the caps high, maybe even unrealistically.

This could mean – and what many unsuspecting consumers may not realize –  that it may also act as an incentive to take on additional risk in the company’s underlying general account investment portfolio.   Insurance company actuaries are good at manipulating numerous ‘moving parts’ that can make attractive caps look better than they really are.  Does a company offering a 13% cap on an indexed product really perform better than one offering only a 10% cap?   According to some extensive back-testing I’ve seen, it doesn’t seem  to be the case – expenses often play a more important role

One major problem for the typical insurance consumer is the inability to tell one company from another.  While many truly professional and credentialed independent agents do make an effort to represent only “investment-grade” companies, there are those who will represent the highest commission, which can often lead to selling substandard products for companies that appear to be substantial.  An agent who is also an investment advisor can be a benefit for the buyer.

6a017c332c5ecb970b017c384ba1fa970b-320wiWhat many don’t know

Most of the well-known rating agencies you may be familiar with are actually paid by the insurance companies they rate!   Little wonder many insurance companies that failed actually had good ratings when they went under.

Have you noticed that virtually all insurance companies tout ratings from the same rating agencies in their promotional materials?  Few, if any, however, tout their rating from Weiss, maybe because Weiss doesn’t get paid by the companies they rate – their revenues come solely from subscriber revenue (kind of like Consumer Reports).

For example, according to the September 2002 Insurance Forum, of 1221 life and health companies rated by Weiss, only 3.9% of companies made it into the ‘A’ category.  Compare that with the 54.9% rated ‘A’ by Standard and Poor’s.  At Moody’s, 90% of their list made it to ‘A’ that year.  A.M. Best gave ‘A’ to 56.3% of the companies they rated.  [Source:  The New Insurance Investment Advisor, Ben G. Baldwin, McGraw-Hill 2002, p. 405.].

By the way, Companies with ratings in the A or B brackets from Weiss are considered secure, while some of the other rating agencies will give B and even A bracket ratings to companies considered vulnerable.

Recently, indexed universal life (IUL) policies have become quite popular – both among agents and their clients.  The reasons are many, but two big attractions are (1) transparency – virtually no hidden moving parts.  These products are easy to understand; and (2) low cost – insurance costs are basically like term policies.  Admin costs are also low and, as noted, everything, including costs, is transparent, including performance going forward.

Does that mean the illustrations can be believed?  No, but for different reasons.  To understand the reasons why illustrations can be misleading and how to know you’re comparing apples with apples, it’s important to know how these policies work.

First a caveat:  This is not an exhaustive text on IUL products and there’s a lot more to know than is being discussed here.  This is simply a quick overview highlighting the stand-out characteristics.

6a017c332c5ecb970b01901bb7b3ed970b-320wiIUL basics

IULs are often, but not always, designed as financial tools for maximum cash accumulation in a tax-advantaged vehicle.  In these cases, the death benefit is often a secondary consideration; however, it’s the life insurance that buys the tax benefits – and, for many, these benefits far outweigh the cost of insurance, which is typically priced like term insurance.

Unlike most insurance buyers who want the most insurance for the least amount of money, these buyers want to buy the minimum amount of insurance for the maximum amount of premium they can put in (yes, there’s a limit).  This is because after the minimum insurance is purchased and expenses are covered, the rest goes into a cash accumulation account; and in an IUL, it can be tied to an index with much higher caps than are usually available in an annuity.

The cash accumulation account accumulates tax-deferred, but can be accessed for retirement income later as tax-free loans.   How fast does the cash accumulate?   Interest is credited to the account based on the performance of an outside index.  While there are often many choices, most people tend to choose the S&P 500 index.

To keep this simple, I’ll just quickly cover the simplest approach:  Let’s suppose our policyholder purchased an IUL policy using the S&P 500 index as the crediting option.  The policy might offer 100% participation in the index’s upside moves up to a ‘cap’ during a crediting period, typically one year.  For example, if the index rises 8% by the  policy’s 1-year anniversary date, the policyholder participates 100% in that move and receives the full 8%, provided the ‘cap’ is higher.  If the index rose by 25% and the policy ‘cap’ was 11%, the policyholder would realize a credit of 11%.

So, on a 1-year, 100% participation with a 11% cap, a 25% rise in the index means the policyholder would receive 11%, i.e., 100% of the increase up to the cap.  That amount would be credited on the policy’s anniversary date

The next crediting would take place on the policyholder’s second anniversary.   Note:  It doesn’t matter what happens between anniversaries – only the value ON the anniversary date counts, nothing else.

The good news is that if the stock market index has a drop, the policy loses nothing.  The amount credited is 0.  No gain, but no loss, either.  Another nice thing is that, in our example above, after the 12% gain is achieved, it’s locked-in.  That’s the new floor and that money can’t be lost.

To understand how beneficial a ‘no-loss’ concept is, it’s worth remembering that while a drop from 100 to 80 represents a 20% loss, to get back to 100 from 80 requires a 25% gain (20 points up from 80 is 20/80 = 25%).

How can the insurance company, investing in a conservative bond portfolio do this?  It’s simple.  Again, I’ll oversimplify with rounded numbers just to make the concept easier.  Premium money received by the insurance company might be invested 95% in bonds, and 5% in stock options.  If the market goes down, the options expire; if the market goes up, they execute the options and, of course, the cap on the policy limits their exposure.  So, the pricing of options, as well as the length, impact costs.

Important:  The policyholder is not invested in the market or the options.  The index is only a ‘ruler’ to measure how much the insurance company will credit.  It’s the insurance company’s investment account that is doing the investing, not the policyholder.

Returns and Illustrations

Can  the policyholder really receive stock market-like returns?  Not likely.  The caps limit the upside, and while there is no downside, down years representing no gain will sometimes occur.  So, positioning IULs as a stock substitute is probably not the best strategy.  I would look for returns that are more bond-like – maybe a little better – which means, it’s the bond portion of your portfolio that you’re really dealing with.

And, here’s where illustrations can be a bit misleading.

If one company is offering a 12% cap and another company is offering an 11% cap, but both are showing you an illustration using a 7% crediting rate, saying that the S&P average over all their back-tested periods indicates that 7% is conservative, are you really seeing an apples-to-apples comparison?

Now that new regulations limit the cap that can be illustrated – remember, however, it’s based on  the ‘current’ cap rates for each company applied to historical data, placing an incentive for the company to keep current rates high – it’s probably better to simply ‘level the playing field’.

First, the company:  How have they treated policyholders in the past when they’ve reduced or increased their caps?  Did existing policyholders receive the same treatment as new policyholders?   Believe it or not, not all insurance companies treat their existing policyholders the way they treat their new ones.

Secondly, a decrease in a cap rate isn’t all bad.  Responsible insurers are custodians for client assets and need to act responsibly, rather than chase risky investments to meet caps they can’t pay.  However, a decrease in the cap also can affect your outcome.

Take a look at the chart below.  Notice a 7% illustrated rate for a 12% cap IUL has had a 79.5% chance historically of meeting its projections, based on a 20-year probability study of the S&P 500 at various cap and crediting rates.  If the cap is 11%, the probability is reduced to 60.7%.

IUL Crediting Rates_001

The new regulations stress average results; but, it provides little comfort to know that your own retirement results have a 50-50 chance of being better or worse.

This has less to do with the insurance company than it does with expectations.  It’s important to know, when you’re buying, what you can reasonably expect; and, often, it may not be what you’ve been promised with a rosy illustration.   High quality companies providing investment-grade products will tend to be conservative in their projections – and a good advisor will educate clients on realistic outcomes.

Key Point:  An illustration for a policy with an 11% cap but using only a 6% crediting rate may not look as rosy as the 7% illustration, but the odds of the company delivering on its promise rises to 95%.  This means, it’s virtually certain your policy will perform this well or better.  The 7% illustration will look so much better at the point of sale, but it also has almost a 40% probability of doing worse than promised.

So, when comparing companies, wouldn’t it make more sense to have them all illustrated at 6%?  By doing so, you could see how they perform on a level playing field with a higher success probability.   You can compare high probability outcomes and, more importantly, a basis for comparing costs, as long as the policies being compared have the same features, riders, etc.

The Real Benefits

If someone begins utilizing these benefits early, say in their 40s or 50s, the retirement benefits can be substantial.  As a matter of fact,  it’s a retirement strategy being used by 85% of Fortune 500 CEOs and many members of Congress in order to create a tax-free retirement.  Other proponents of this strategy include retirement and IRA expert Ed Slott, who is also a CPA, and David M. Walker, former US Comptroller General [Source: The Power of Zero, David McKnight].

I’ve created a report on this concept.  You might find it interesting.  You’ll receive it free by going here.  If you’d rather take the time (about an hour) and view the webinar with all the slides, you can do that here.




6a017c332c5ecb970b019aff2c523c970c-320wiNo?  You’re not alone.

Very few families ever sit down together and talk over important issues.   Too bad; it’s important.   It should be considered an integral component in “the business of living”.

According to an excellent article in the current issue of the Journal of Financial Planning, there are four key areas every family should discuss:

  1. Legal issues:  Who has the durable power?  Who will be executor for the wills?  Do they have trusts?
  2. Health care:  What happens if mom and dad get sick?  Who takes care of them?  Where are they going to live and how are they going to pay for their care?
  3. Financial:  Are the parents financially secure?  Will they need help from the children?  It’s a tough conversation to have, but children need to know this stuff in advance.
  4. Legacy:  More than who gets what; it’s about what you want your children and grandchildren to remember about you.

Ideally, the meeting should have a good facilitator.  Your financial advisor, if s/he’s been at the center of your financial planning – which should be the case – might be the perfect person.  The facilitator doesn’t control or direct; but, can provide an objective and worthwhile service.  In addition, you may want to include your family attorney in the meeting to address legal issues and  provide valuable input.  And, one of the adult children should be the note-taker to follow up on who is to do what and by when.

One meeting isn’t a magic pill, and it won’t correct all past problems; but it’s a start.  After all, it’s about helping parents when they’ll need it most.



Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.


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James Lorenzen, CFP®, AIF®

For years we’ve heard about “The 4% Rule”.  Of course, that’s when the markets seemed to be going up all the time.  In recent years, due to low interest rates and increased market volatility introducing everyone to sequence-of-returns risk, – I even did a webinar on this topic –  many advisors have dialed back the 4% withdrawal rate to 3.5%

Testing with annuities

A Journal paper in December 2001 by Mark Warshawsky and co-authors John Ameriks and Bob Veres introduced the use of immediate annuities into the retirement discussion.  In his current contribution, Warschawsky  examines  the use of immediate annuities combined with a fixed withdrawal percentage from a total-return portfolio.  The conclusions [1] were:

  • The 4% rule tends to fail when utilized for extended periods, i.e., 30 years, whereas immediate annuities provide continual cash flow, regardless of market or economic
  • A 3.5% or less is often more appropriate than 4% (for obvious reasons).
  • When incorporating an immediate annuity at age 70, the annual payout almost always exceeds the 4% rule and does not risk full income or running out of money – in essence it’s purchasing an unending cash flow that, testing shows, exceeds the 4% rate.

Immediate annuities offer many advantages, but they likely not suitable for those with impaired longevity, liquidity needs, and adequate pension income.  If you like to learn more, you can access the Income Annuity Primer.

Testing with insurance

Wade Pfau, in a paper commissioned by OneAmerica, addresses this issue in three scenarios:

  1. Investments combined with term life insurance
  2. Investments, joint and 100% survivor annuity, and term insurance
  3. Investments, single life annuity, and whole life insurance[2]

He compared these three approaches for 35 year-old and 50 year-old couples.  Without getting into the weeds, I just say his study found a “substantive evidence that an integrated approach with investments, whole life insurance, and income annuities provide more efficient retirement outcomes than relying on investments alone.”  It’s not an either/or decision.

Withdrawal strategies vary  beyond what’s  been discussed here, of course, which is why professional help can be very important and the difference of even hundreds of thousands of dollars.

It pays to do your homework and have a good guide.


Interested in becoming an IFG client?  Why play phone-tag?  You can easily schedule your introductory call right here!

[1] Journal of Financial Planning, January 2016

[2] ibid

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® serving private clients since 1991.  Opinions expressed are those of the author and do not represent the opinions of IFG any IFG affiliate or associated entity.The Independent Financial Group is a fee-only registered investment advisor with clients located across the U.S.  He is also licensed for insurance as an independent agent under California license 0C00742. Jim can be reached at 805.265.5416 or (from outside California) at 800.257.6659. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  


Time_Is_MoneyJim Lorenzen, CFP®, AIF®

The key to pursuing longer-term financial goals, such as retirement and education funding, is to have a well-thought-out plan that assigns actual dollar amounts to each goal — and a timetable for getting there.

Financial resolutions are only as good as your follow-through. Here are some planning considerations for the three key stages of your financial life — accumulation, preservation, and transfer.

Rethinking your financial priorities?   Here’s some food for thought for all of your goals:

Financial resolutions are only as good as your follow-through. Here are some planning considerations for the three key stages of your financial life — accumulation, preservation, and transfer.

These same resolutions often fall prey to the same procrastination that hinders personal aspirations. Yet current volatility in the financial markets along with other unsettling factors such as the impending presidential election and widespread geopolitical unrest may have led investors to pause, rethink their financial situations, and set new expectations for the future.

Resolutions typically fall into one of three financial “life stages” — accumulation, preservation, or transfer of wealth.  In order to establish action plans for these phases, you need to examine opportunities, identify challenges, and add a dose of reality to your planning efforts.

Accumulating AssetsiStock_000003860264-FemaleLeader

The key to pursuing longer-term financial goals, such as retirement and education funding, is to have a well-thought-out plan that assigns actual dollar amounts to each goal — and a timetable for getting there. On this score, many investors are falling well short of the mark.

For instance, research compiled by the Employee Benefit Research Institute (EBRI) indicates that a sizeable percentage of workers say they have virtually no money in savings and investments.*  Specifically, among workers who provided this type of information, 57% reported that the total value of their household’s savings and investments, excluding the value of their primary home and any defined benefit plans, is less than $25,000. This includes 28% who say they have less than $1,000 in savings.*

If you find yourself behind in your accumulation efforts for major life expenses, such as retirement, don’t despair. There are many opportunities to jump-start your savings campaign.

  • Make the most of employer-sponsored plans. For participants in 401(k)s, 403(b)s, and 457 plans, the contribution limit stands at $18,000 for 2016 with an additional $6,000 in catch-up contributions allowed for those who are 50 or older.
  • Maximize IRA contributions. In 2016, you can contribute up to $5,500 to a traditional or Roth IRA (or split that amount between the two types of accounts). Add another $1,000 to that total if you are making catch-up contributions.
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Preserving Assets      

Holding on to your assets requires a disciplined, long-term view. Most people plan for a retirement to span 25-plus years, but evaluate their portfolios’ performance over the last quarter. Particularly in volatile market environments, investors tend to move in and out of positions too quickly, potentially causing them to sell low, buy high, and abandon asset allocation fundamentals.

Short-term declines are inevitable and may tempt the most grounded investor to make impulsive investment choices. That is why maintaining an investment policy statement that reflects your long-term horizon is essential. Such a statement should reflect your current investment expectations as well as address the tax consequences of your portfolio.

For instance, many investors tend to hold on to a stock because of a low basis without evaluating what it may be costing them in missed opportunities (i.e., building a more diversified portfolio).  Alternatively, investors need to be mindful of the tax cost associated with buying and selling securities. Tax efficiency is important in asset preservation, so speak to your tax advisor now about your 2016 strategy, particularly if you plan to rebalance your portfolio.

Transferring Assets

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To leave the legacy that you envision requires significant advance planning. Questions regarding how much you want to leave to loved ones, how long your bequest will last, and how much will be eroded by taxes are difficult to address. But planning converts uncertainty into real opportunities to make a difference.

When crafting your estate plan, be sure that documents are written to be flexible and easily adapted to changing circumstances. For instance, if balances on investment accounts decline, you may need to rethink — and restate — your intentions, perhaps even change beneficiary designations to reflect changing market dynamics.

IFG Notes:

Not everyone agrees with conventional wisdom regarding the 401(k).   There might be other options, particularly for those who are concerned about future tax hikes and still have more than ten years before they begin drawing retirement income.

Don’t let procrastination get the better of your best-laid plans. Make 2016 the year you get serious about saving.  Are you on track?

You can find some tools on the IFG Resources website, which is different from The IFG main site, which you can find   here.  You might check-out the Home Page, too, for even more resources.

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Let me know if I can be of help!


*Employee Benefit Research Institute, 2015 Retirement Confidence Survey, April 2015.2Asset allocation does not assure a profit or protect against a loss.

Because of the possibility of human or mechanical error by Wealth Management Systems Inc. or its sources, neither Wealth Management Systems Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Wealth Management Systems Inc. be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content. © 2016 Wealth Management Systems Inc. All rights reserved.



Should Investing Be Fun?


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Jim Lorenzen, CFP®, AIF®

“If you think investing is fun, you’re doing something wrong.”                                                – Warren Buffett

I’ll never forget visiting with a nice couple who was seeking advice on planning and investing.  All of a sudden one of them piped-up and said, “I really like trading; it’s fun, and I’ve been pretty good at it.”

When I asked how they did during the market meltdown, I was told they broke even.  I guess they were  like everyone you know who just returned from Las Vegas.

I guess there must  be a lot of people who do, considering all the active trading commercials you see on television, despite all the educational resources available that debunk it’s effectiveness on a consistent basis.  If Warren Buffett won’t do it, why should I?

One colleague tells his clients that pain in a strong indicator of good investing.  In other words, if a potential buy feels right, it’s probably best to hold off.

Studies seem to prove reveal that the human mind is often disconnected from reality.   If their feelings toward an activity are positive, they are naturally moved to judging the risk as low.  This explains why so many tend to buy when the market’s good and sell when it goes down.  Not surprisingly, a whole new field of behavioral finance has emerged that explains how we can think we’re being logical even as we do illogical things:

Data mining:  We tend to look for patterns that validate our beliefs.

Recency bias:  If stocks fall, we expect it will continue.  When they go up, we think that will continue, as well.  The most recent events are more important than an event that happened three months – or years – ago.

Confirmation bias:  When stocks go down, our belief is confirmed that stocks are high risk and low reward – which is why so many move to cash until the market comes back (buying high).

Herd effect:  While many investors believe they’re contrarians, research shows the human animal is more likely to follow the herd. – because we believe the herd is led by experts.

The fact is there are many other risks out there, often ignored by those trying to build their retirement asset base.  I even recorded a webinar about why many retirement plans are doomed to failure.  The important note is sometimes lost:  Those who begin early – and do it right – virtually always outperform those who do it wrong until they’re 65 and worried.

When it comes to trading, maybe Warren Buffett just might know something our nice couple didn’t.