Whole Life (WL) is the most complex product ever developed by the life insurance industry. Complex in the sense it cannot be broken down into its parts. It is a bundled product.
Anyone who intends to read this write should first read the “How it Works – Whole Life Box” write up. It provides a design framework that sets the stage for a more detailed discussion of WL’s various moving parts. I would also suggest reading the “WL Design Basics”, WL Guarantees” and “WL Dividends” write up’s before reading this one. The combination provides a sound foundation to understand the following discussion on dividends.
INTRODUCTORY COMMENTS
The WL box story focuses on a conceptual understanding of the product. The Design Basic’s write up gives an overview of formulas and assumptions that create WL illustrations and subsequent calculation of actual values. The “guarantees” write up discusses the foundation upon which dividend based values are added. These constitute an important first step in gaining a better understanding how this ridiculously complex product works. Suffice it to say, WL is not the “simple” product many who sell it seem to believe it to be.
If it were a simple product this “How it Works” series could not contain almost a dozen 20 and 30 page write-ups on the product. There would be no need for this avalanche of information.
What complicates matters with WL is the fact it is a bundled product. One where all the moving parts are obscured. No individual income or expense information is ever made available to those who sell it, or those who buy it. Only a few company executives and actuaries have access to this information.
Those who favor selling WL often base their understanding on a handful of half-truths and misunderstandings shared with them as fact by under informed or misinformed (albeit well intentioned) mentors or peers. A bold statement perhaps, but sadly one that all too often has proven to be true.
Only when a properly educated individual asks detailed questions (the answers to which they already know) does the validity of the above statement become painfully clear. Those who understand how WL works are endlessly amused (or saddened) when witnessing the floundering efforts of those who do not attempting to explain it to others who do.
Offsetting this lack of knowledge, or perhaps because of it, WL is often sold with an almost evangelical fervor. Assertions surrounding its guarantees often make the product sound as if it embodies all that is good and holy. A biblical level of enthusiasm often prevails.
Unfortunately, even those with the best of intentions and deeply held beliefs can end up making blatant misrepresentations. Which can be every bit as damaging as the falsehoods shared by those with ill intent. Or, worse since considering the level of sincerity of the person sharing the misinformation.
The WL product itself is neither good nor bad. It’s just a design developed before the advent of computers which made it possible to track every little detail of a products structure. Computers also made it possible to track and report each and every income and expense factor on an individualized policy owner basis. Imagine the challenge of attempting to do so with tens of thousands of policyholders with a manual hand based calculation and posting system.
The decade’s old design of WL allows cash values to accumulate within a policy and death benefits to be paid covering said tens of thousands of policy holders. Its design allows this to be done without the need to segregate the general account assets that support the cash values in any given individual policy. The same is true with the expenses paid from the general account.
With WL those factors are bundled together and allocated based on formulas embedded in the WL product design. This collection of interrelated formulas is often referred to as the “master” WL formula. Which differs for every individual WL product ever sold.
As with any product design WL has its plusses and minuses. What makes WL good or bad at any given point time is a function of what is, or has transpired in the real world since its sale.
So, at any given time and depending solely on economic and other realities, WL may or may not be the best product for any given person. Something that also depends on the intended use of the product and the focus of any given purchasers goals or needs.
As noted earlier, it does not require ill intent to misrepresent a products features or benefits. Ignorance works just as well. Most of those who sell WL have nothing but the best of intent. It’s just their lack of actual knowledge that creates problems. The WL product is typically sold as a product rift with guarantees that eliminate all the elements of risk. Which sadly just isn’t so.
Economic trends, in particular those pertaining to interest rates, have a tremendous impact on WL products since it is an interest sensitive product. As a result, whatever is happening with interest rates (or whatever has happened since the product was purchased) has a tremendous impact on the products ability to deliver on illustrated cash values, dividends and death benefits.
Regulations also have a tremendous impact on the value a WL product can deliver. Among a great many other things regulations prohibit investing general account funds in equities (stocks). They allow only a modest level of stock ownership which usually relates only to stock owned in subsidiaries of the company selling the WL product. Beyond this regulations also require reserves for different asset classes that can impose tremendous cost levels and capital constraints on companies selling WL products.
The reality of interest rates today could not possibly be more different than the reality of interest rates that existed decades ago in the heyday of WL product sales. In fact, the realities today are literally 180 degrees opposite.
As the number of other “How it Works” WL write ups suggests this is only one of many factors impacting existing policy holders and new potential buyers of WL products today. But it is a very important factor that has crippled the WL product for the last two or three decades.
SURRENDER CHARGES
There are those who earnestly argue WL policies have no surrender charges.
This foolishness is made possible by the fact WL, as opposed to Universal Life (UL), has no separately stated “account value” that can be compared to the available policy cash surrender value. It simply shows one value, that being the available “cash surrender value”. The word “surrender” being the operative word.
Of course, any company producing illustrations can simply drop the word “surrender” and use the two words “cash value” for that column.
The UL product is an “unbundled” life product. Meaning its design takes great pains to make all its moving parts visible. WL is a “bundled” product. Meaning all its moving parts are integrated and inseparable from one another.
With the UL policy design the account value is the cash value amount that is invested and working for the client after all income from the past have been added and all expenses subtracted. It appears with that label on all illustrations as is the case on all policy summary statements.
The cash surrender value is the reduced amount that can be accessed for withdrawals or loans, or upon a full surrender of the policy. It differs from the account “invested” value based on a series of declining percentages disclosed as a table in illustrations and product brochures.
The “surrender charge table” percentages are multiplied times the “account value” to determine the portion of that value that is available to the policy owner. This “available” surrender value can be accessed by borrowing, withdrawals or in total if the policy itself is surrendered (cashed in). .
So, with the UL policy design the account value is the amount invested and working for the client while the surrender value is the amount that can be accessed by the policy owner. Very clear, simple and totally clarified for all to see.
With the WL design there is no value stipulated as “invested and working for the client”. No effort is ever made to break down the general account total balance into each policyholder’s share of the total. The general account is not “allocated” to individual policy owners. They don’t own a portion of it.
The general account is “owned” by the life insurance company and is accounted for as a company asset. The cash surrender values of all outstanding WL policies is accounted for a liability. Liabilities in the accounting world offset asset values. The balance remaining after total liabilities are deducted from total assets determines a company’s “capital” level.
The amount of capital in turn is used to determine a company’s financial strength rating (along with the quality of assets making up its general account) and to meet regulatory capital level requirements.
No such concept exists with WL.
Absent a published surrender charge table and the two column UL disclosure approach it’s not possible for any given policyholder to figure out how much of what they’ve paid in premiums (increased by earnings and reduced by expenses) remains invested and working for them in the unallocated general account. The cash surrender value they see in illustrations and annual statements is developed within the WL policies master formula, into which the surrender value table is embedded (or hidden if we elect to use that perspective).
So, with the WL design there is no table shown in the illustration footnotes or in the product brochures. The surrender factors instead are part of the master formula and its assumptions, which as prior write-ups have discussed, are never disclosed to policy owners (or those who sell WL products).
It is the series of interconnected formulas that make up the “master formula” that determines all illustrated and subsequent actual policy values, including cash surrender values.
As is the case with the UL product and its table reflecting a series of declining percentages, the percentages factors in the WL product decline over time. That said, they typically decline at a far slower rate than with UL products. Which is another way of saying the surrender factors in WL extend for many more years than with UL products.
The intent of these surrender factors that reduce the cash value the WL policy holder can access is not to punish the WL policy owner if they need to access their cash values. Instead, the intent is to allow the WL companies money managers to invest the premiums these owners pay for longer time frames in illiquid assets. The reason being those types of fixed interest investments historically have far higher yields than shorter term or more liquid alternatives.
If the access to premiums paid and subsequent earnings on those premiums were not restricted in this manner, the money managers could not invest in longer term, illiquid alternatives without creating extreme levels of principal risk. The reason being if market interest rates go up the value of longer term, illiquid assets goes down. The more dramatic the upturn in market rates, the more dramatic the decline in asset values.
If access to cash values were not restricted and WL policy owners could withdraw the prior premiums they paid at will, the money manager would be forced sell general account assets at a loss to fund those loans, withdrawals or policy surrenders. Those losses would then be absorbed by all the remaining policy holders. Which would not be fair.
The imposition of a surrender penalty on the policy holder who is accessing their cash values is deemed a far fairer end result. The fact that access rights are restricted is intended to discourage any given policy owners from deciding to access their policy cash values. Especially early in the life of a WL policy when the surrender percentage factors are typically 100% for several years.
The fact WL has only one cash value column and no published surrender table explains the origin of the myth that there are no surrender charges in WL. Those that cling to that flawed belief hang their hat on the fact there is no account value to measure cash surrender value against as is the case with the UL product design.
This thought is ridiculous since one can clearly see the after the payment of one or more base WL premiums that there is a zero cash surrender value shown on policy illustrations and statements.
Obviously, there is a surrender charge. The lack of disclosure in footnotes or product brochures does not mean the master formula and all its components do not exist. Unless, that is, someone decides to delude themselves to believe that is the case.
Utter foolishness.
Trying to understand an aspect of WL by relating it to UL design logic simply doesn’t work. The designs behind the two products are mutually exclusive. One is a bundled product. One is an unbundled product. The twain shall never meet.
The fact is, as with all things relating to WL, hidden formulas govern all calculations. And, within one of the many separate formulas that combine to make up the master formula is a series of declining percentage factors that suppresses access to a given percentage of previously paid premiums and earnings at any given policy year end.
NOTE: Just because the policy owner’s access to previously paid base WL premiums is suppressed does not mean those values are not invested and working for the policyholder in the general account. Even though there is no “account value” shown for WL policies, clearly those premiums have been invested and they are working in the general account producing returns.
With WL the above noted formulas dictate when a policyholder will gain access to the premiums paid in the past and subsequent earnings above expenses.
Clearly, the suppression of values is a surrender charge; whether the surrender amount is clearly shown in the illustration; as is the case with UL, or whether it’s imbedded in a formula; as is the case with WL.
When the cash value available is lower than the total of premiums paid, clearly a surrender penalty is at work. It’s that simple.
WRAP UP COMMENTS
The existence of surrender charges in a WL policy only matters for a period of time. Albeit a longer period of time than is typical with UL products. After which the full value produced by the formulas that govern these things for any given company will be available to the policy owner.
Relative to WL there are many other realities that have changed, and numerous areas of complexity and misunderstanding. To learn more about these things I’d urge continued reading of more of the “How it Works” write ups on WL.
Required reading for the inquiring mind.
