What is a life insurance illustration?
Unless you’ve met or at least talked to a life insurance agent or you’ve done extensive homework on life insurance policies, you may not have a good handle on illustrations. What are they? Why are they useful? What do I need to know about them?
For most life insurance policies, a prospective insured must be given an illustration detailing how the policy might perform given certain assumptions. The key words to remember are “might” and “assumptions”. More on that in a bit.
These illustrations are typically required at the time of sale. There are exceptions depending on the state you are in. Most prospective insureds should steer clear of those exceptions as those policies tend to fill very specific needs.
Thanks to the NCIC (National Association of Insurance Commissioners) life insurance illustrations are mostly standardized so they are presented in a similar format. So if you’ve seen one, you’ve seen them all… right? Well, almost.
While illustration formats are standardized – what’s inside may vary greatly
While the formats are similar, the illustrations themselves can vary widely. This is due to several factors, including options chosen by the prospective insured and possibly choices made by the agent. You can expect to see sections such as details of the plan, riders (options) included, and the premium. You’ll also see a written description of the plan, along with some further details on riders and some definitions. Expect to see some graphs. Each illustration will have a “guaranteed” and “non-guaranteed” section. Things that are guaranteed might include the death benefit and the premium. The most important non-guaranteed item would be the dividend. This is where the assumptions enter in.
Guaranteed vs Non-guaranteed Items
Each type is important! Know the difference.
Guaranteed items will never change.
Non-guaranteed items, such as dividends, depend on certain factors, such as how well the insurance company performs financially.
Non-guaranteed items can have a significant impact on your policy. Understanding this can help you spot overly optimistic projections.
For a fixed-rate policy, your premium is pretty much set in stone. It is not going to change. The death benefit can change but generally only for the better. The death benefit can increase as the policy accumulates paid up additions. Think of these as micro-policies tacked on to the policy. Paid up additions are the result of dividends paid by the insurance company. The policy owner opts to have them paid this way for the very reason of adding to the cash value of the policy.
Assumptions comprise the heart of an illustration. Pay close attention to them.
When an agent generates an illustration, s/he enters in an estimate of what future dividends might be. This is the “assumption” and is often based on the past performance of the insurance company. Depending on the agent’s point of view, these assumptions can range from very conservative to wildly optimistic, though one might expect most to land somewhere in the middle. Note here, modern software enables agents to generate illustrations in seconds. This can be good and not-so-good. The good part is if you feel the illustration is too unrealistic, you can ask the agent to try another figure. The not-so-good part is one can easily be swamped with far too many variations for comfort. As most good mutual insurers consistently pay a 4-5% dividend, I recommend requesting an illustration assuming a 3% dividend rate. This somewhat conservative approach provides a reasonable worst-case scenario while allowing for an apples to apples comparison of policies.
Pro Tip: Use Illustrations to Compare Policies
To compare policies, ask for illustrations with a specified assumption, say a 3% dividend rate.
All of the financial aspects are calculated year by year from the current date to when the policy endows or ends. The results are displayed in table, showing the year by year growth to be expected should the assumption prove correct. The idea is to show the prospective insured what the policy might look like over the coming years. The problem here is nobody can predict the future so any assumptions will be wrong. In addition to the dividend rate, other factors that could affect the cash value accumulation include policy loans, missed payments and changes to the policy itself. In a perfect world, none of these things will happen and the dividends will always roll in at a greater rate than one assumed.
Already have a policy in place? Ask for an “in-force” illustration to see how your policy is performing.
Anytime after you purchase the policy, you can ask for an “in-force” illustration. This will be an updated version providing you with the real-world performance of your policy. Most insurance companies will provide this free of charge but they may not be required to do so.
When looking at the table, you will likely notice you are paying more in premiums, sometimes far more, early in the life of the policy than what is accumulating in your cash value. This is to be expected. Keep in mind, should the worst happen, the insurance company will have to write a check for full death benefit under normal circumstances. At some point the cash value will often catch up or even surpass the premiums paid in. You read that right and yes, it does mean the policy is now worth more than you paid for it.
Before you get too giddy, I’m sure someone will come along to tell you how much you could have made had you invested this money as opposed to sinking it into an insurance policy. That’s okay. This isn’t an investment. It’s life insurance done properly with realistic goals and a sound purpose. If the worst did happen, your “investment” would be limited to whatever was accumulated to date, subject to probate and income tax in most cases.
Summing up…
To summarize, a life insurance illustration is a snapshot of a policy, either proposed or in-force. For a proposed policy, the assumptions deserve close consideration. The only thing guaranteed about an assumption is the assumption will be wrong. By deciding on an assumed rate, such as 3%, to use for illustrations on different policies you can then compare apples to apples and potentially spot any differences between those policies to help you make an more informed decision. You can also request an in-force illustration on any policy you own. It may be helpful to compare it with the original illustration to determine how the policy performed versus your expectations.
Always compare illustrations before you sign on the dotted line.
Understanding the basics of illustrations is a key factor when choosing a life insurance policy. By comparing illustrations with similar assumptions, it may help you decide which one you prefer. Take into consideration that dividends are never guaranteed, neither are the growth projections. That said, you may gain a better understanding of how differences in rates may affect your policy’s performance.
Since most of what you need to know will be in the illustrations, they are the number one tool needed to make sound decisions when buying life insurance. Pay close attention to what items are in the guaranteed portion versus the non-guaranteed part.
Going further…
Learn more about protecting your and your family in my new book “Life Insurance “Dirty Little Secrets” for Consumers Revealed!”. Even if you already have life insurance, there are things you should know. For those still unprotected, this slim volume answers those questions that keep most people from securing a solid, affordable policy. You’ll learn what to look for in an insurance company and a good policy to provide financial security for you and your family. Rather than being “sold” a policy, “Life Insurance “Dirty Little Secrets” for Consumers Revealed!” empowers you to seek out and secure the coverage that best works for you.
