What’s the Difference Between a Guaranteed and a Non Guaranteed Illustration?
A question that I get all the time,
The difference between guaranteed and non guaranteed illustrations are important to know, especially in the case of an indexed universal life policy, where the cash value and expected years of insurance coverage is going to be based off of non guaranteed illustrations.
Just to back up a bit, an illustration looks like this:
It is a year by year detail of how the company expects their life insurance company to perform.
For term policies it’s pretty simple: it’s guaranteed for the amount of the term and has no cash value so the non guaranteed and guaranteed illustrations are exactly the same.
Guaranteed universal life also falls into a similar category – the worst case assumptions are built into the design of the policy – the no lapse guarantee takes the place of any meaningful cash value, so even in a rosy scenario they don’t change very much. What you see is what you get.
Index Universal Life and Variable Universal life on the other hand have quite a bit of variance, (as you can already see from the above chart). Both of these policies need to do better than their guaranteed assumptions to be a compelling offering – otherwise you would have been better off with the Guaranteed Universal Life policy.
But how do these different illustrations come about? And are they too optimistic?
Originally, in the dark ages of the world, you could just promise something to somebody but all you really had to go on was their word. If someone hookwinked you, chances were you either out of luck or you killed the bastard in revenge.
With the advent of the rule of law, humanity was able to climb out of this suck pit. However, this happened quicker in some industries than it did others.
Life insurance was originally sold by small, locally based companies
If you look carefully in small American downtowns, you can still see the name of old life insurance companies on the buildings that either went out of business or had to merge with larger, more well known companies to survive.
These small companies were all trust based. There were no backstop laws that protected consumers if any of these small companies failed, which sometimes happened.
What Happened Next?
In the not too distant past (we are talking midtwenth century here) life insurance laws were finally modernized.
These laws did a couple of things:
These laws forced insurance companies to keep reserves (cash on hand to pay claims), limited their ability to speculate in the general account (there was a swampland craze in the 1920s, after all), and forced the industry to publish somewhat realistic assumptions of whole life illustrations (remember UL and IUL policies hadn’t been invented yet)
Why Does This Matter To You?
Assuming you managed to slog through the previous paragraphs (I know, I’m sorry), you are probably asking the question – “Well what does this have to do we me?”
The answer to that of course is nothing, unless you are planning on owning a permanent policy.
When the your insurance agent shows you (myself included) how wonderful your policy is and how it will pay for itself and generate you oodles of cash – all of that is based on a future interest rate that is assumed. All agents are required to present at least two scenarios to you, guaranteed and non guaranteed.
The Guaranteed Assumption
Because of the regulations that were implemented, the guaranteed illustration is conservative – like your grandfather at the thanksgiving table conservative!
It essentially assumes a never ending recession with negative real returns on stocks and bonds the entire time – which has never before occurred in the United States. It is more likely in fact, that the United States would fall apart before your policy did – seriously!
I tell clients all the time that if they ever have a misfortune of living in a scenario where their policy is at its guaranteed floor – beans and ammo are only two forms of currency left worth having anyway.
The Non Guaranteed Assumption
While the Guaranteed Assumption should put your mind at rest – whatever those numbers show will be true as long as we still have a flag, every agent emphasizes the non guaranteed numbers.
Again, because of regulation, these numbers have to be realistic, but the definition of ‘realistic’ has always been somewhat hazy.
Lots of agents have gotten their clients into trouble by presenting ruthlessly optimistic interest rate returns, when the reality has been far different. I have seen Indexed Life Insurance rates presented as high as 11% – which only takes place in a world where we all become millionaires and are enjoying our yachts and second homes.
Really, the economic growth required to get there would put this country in the best financial position it has ever been in- ever!
Because of the large gulf between the worst and the best – you have to be have to be on guard when an agent is showing you any policy that can build up cash values.
The ethical agents generally use the current interest or carrier default – but even those can be all over the place
Protective expects an average interest crediting rate of 5.6% (minus costs) for its Indexed Product linked to the S&P 500, where AIG projects 6.86% (minus costs) for it’s IUL linked to the S&P 500.
Doesn’t sound like a lot right? Here’s thing thing – compound interest is a big deal! Even just two percent more leads to having twice as much money over a 35 year period – which also means having half as much money if it’s two percent less.
Moral of the Story
Watch your interest crediting assumptions!!! Laugh at anyone who tells you about a 10% return and be very skeptical of anyone who tells you 8% or more!
They may tell you they can save you much more than any other agent, but remember, “There is no free lunch”. You can pay less now but you will end paying more for it later!
In case you are curious, I myself quote at the carrier’s current assumption rate for two reasons:
- Life insurance carriers are filled with very smart nerds who crunch numbers all day. These people (while not super sociable) are far, far smarter than me and far more familiar with predicting an insurer’s likely future future income. I am not going to muck up their data driven conclusions with a gut feeling.
- If a state regulator ever came to me with an audit and asked what I was selling my clients, I can point to the fact that all of my illustrations were at the company’s current assumptions, not my own.
Conversely, don’t fret about the lack cash value in guaranteed column
You now know that they are extremely conservative – your policy will almost certainly perform somewhere at, above, or below the current rate, but nowhere close to the floor.
Interested in learning more? If you’re looking for an ethical agent who will put you first, look no farther! Schedule a free consultation today! If you’re not a fan of calendars, just shoot me an email.