Policy management is one of the most overlooked services a broker can provide. Premiums and cash value returns need to be managed just like any other financial asset.
In this article, we explore the concept of policy management for variable life insurance.
The world of cash value life insurance is divided into two camps: the general. account and the separate account. Insurance companies make the investment choices with general account life insurance products.
Investments are limited primarily to bonds and mortgages because of reserve requirements. Investment results for general account products change relatively slowly. Unless the insurance company declares bankruptcy, cash values never suffer a loss since they are backed by minimum guarantees.
Separate account products allow theclient to invest cash values in a wider range of sub-accounts, which can include equities, metals, bonds, indexes, and so forth. Investment results are volatile and unpredictable. The occasional cash value losses, which can be dramatic, can put principal at risk.
Avoid Complacency
During a bull market, all clients think that they can manage a portfolio. Investment professionals can become complacent too by assuming the client’s needs won’t change and that tomorrow will be the same as today. In my two decades in the business, I have seen four vastly different economic environments. In each of these periods, insurance professionals mistakenly assumed that current conditions would persist indefinitely. A true professional approaches investing with all economic circumstances in mind.
This is where Nobel Laureate, Harry Markowitz comes in. He developed the Modern Portfolio Theory in the 1950s. It’s based on the concept that investors care about avoiding risk as well as seeking a return. The Modern Portfolio Theory proves that you can reduce a portfolio’s volatility by diversifying into more volatile asset classes with a low correlation.
The standard deviation in a portfolio reduces the lower the correlations between composite asset classes.
This concept seems counterintuitive. It may be hard to convince a client that they could actually reduce the volatility of their portfolio by investing in a more volatile asset class.
Using Markowitz’s theory that investors are naturally risk averse, you can create a set of optimal portfolios based on risk and return. You can actually decrease the risk and increase your return by diversifying from bonds into stocks. But, it is not always a matter of simply moving out of bonds and into stocks. The lack of diversification has been the easiest challenge for litigation since it is easier to prove than specific imprudence.
Asset Allocation As Part
of Diversification
Diversification has evolved to include asset allocation. A number of studies have concluded that asset allocation decisions have the greatest effect on a portfolio’s long-term performance.
Asset allocation decisions account for 92% of a portfolio’s performance variance; 2% is due to timing the portfolio positions; 3% is due to security selection; and 3% is pure luck.
Asset allocation is based on the principle that asset classes have different investment characteristics and they can be combined to optimize the objectives of the investment policy statement.
You can determine the optimal mix of asset classes to yield the expected rate-of-return with the least volatility. For any level of assumed volatility, you can get a higher expected return by mixing different asset classes than you can by investing in a single asset class.
All products have risks, but a good life insurance agent or broker helps clients make informed decisions about the merits and risks of various products. The client needs to understand that part of the risk of the variable policy is that they would have to pay additional premium or scale back the death benefit if the sub-account performance is less than 6%.
There is also the risk that the company will change the costs of insurance. With a general account product, if an insurance company became insolvent, the policy owner would become a general creditor for any benefits owed including cash values. This is especially true for a policy that relies on secondary guarantees.
When insurance companies have hit the skids, rehabilitators have had the unilateral power to give policyholders new contracts under different terms. Buyers of secondary guarantee products must be aware that insolvencies may result in a rehabilitator changing the deal. There is no such thing as a risk-free financial transaction, but variable life offers much more protection for policyholders than does a secondary product.
Considerations For
Asset Allocation
Prudent management of policy account values depends on diversifying assets. To implement an efficient frontier portfolio, you must consider three variables for every asset allocation decision:
Time Horizon: Studies too numerous to mention have proven that time is an investor’s greatest ally. But, few investors have the patience to let time drive the return. They get caught up in the hype and short-term direction of the financial markets. Research has shown consistently that the longer a portfolio can remain invested, the more aggressively it can be diversified without compromising the investors’ assumed risk tolerance.
Assumed Risk Tolerance: Risk is defined as the probability or likelihood of not attaining one’s investment objectives in a given period. Mixing cash and bonds may be suitable for short-term investing, but may not be suitable not for long-term investment portfolios. Inflation over an extended period can deteriorate the real return of a fixed income portfolio. Considering the definition of risk, any policy management must set an expected return objective that is suitable for the policy owner.
Expected Rate of Return: It’s gotten increasingly difficult to for clients to have realistic return expectations because of purported investment returns that are touted in financial marketing materials and press releases. Investors have grown accustomed to bull markets and almost automatic double-digit returns. However, setting unrealistically high return expectations can create never-ending problems as long-term investment strategies and funding policies are carried out.
Monitoring investment performance and maintaining a contract management system must go beyond simply reviewing manager figures. A portfolio manager may need to be replaced due to changes in style, staff, or objectives. Contract management should not be viewed as static.
As circumstances change, asset mixes, and investment managers may change without a portfolio manager’s performance going below expectations or objectives. In summary, policy management is one of the most valuable services that a broker can provide to a policyholder.
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Richard Landsberg is director of Advanced Sales with Nationwide Financial Services Inc. in Columbus, Ohio. He can be reached atlandsbr@nationwide.com.
