In the wealth management world, basis points mean everything. Hedge funds may charge 100 to 200 basis points plus a performance fee. Funds of funds typically charge 50 to 100 basis points plus a performance fee. The model for wealth management firms could be 50 basis points for managing a $10 million portfolio.
Wealthy individuals and families pay close attention to basis points. It is not uncommon for an asset manager to be fired over 5 to 10 basis points—whether the points are reflected in performance or administrative costs.
The bottom line is that basis points matter—and advisors should be aware that basis points in the context of life insurance are no exception.
Advisors have opportunities to achieve meaningful basis point reductions inside life insurance policies. Many affluent families are unaware of the impact lower basis point charges can have on this asset class and how to take advantage of the possibility.
The potential solution can be found in the genesis of life insurance products designed specifically for the affluent buyer and the ability to segment experience to create a separate risk pool for policyholders.
Lower Pricing
In 1978, a group of life insurance advisors approached product manufacturers with an intriguing opportunity. These advisors served wealthy individuals who exhibited superior experience in three areas at the heart of life insurance product design and pricing: They had higher-than-average mortality (they lived longer primarily because of access to the best health care), they purchased larger amounts of insurance (which created efficiencies via lower unit costs for the carriers) and they kept their policies in force for longer periods of time (because they purchased life insurance for a specific need and had the resources to pay the premiums). Based on these characteristics, the advisors believed these clients deserved to be treated differently, specifically with products priced with these advantages.
The carriers listened and agreed the opportunity was intriguing. But they needed proof to justify the lower pricing for these clients.
So the advisors began collecting data—through Security Life of Denver, a reinsurance company they created with their own capital—in an effort to support their observations about these clients. The result is several decades worth of data that uncovered key characteristics of the affluent insurance market:
• The mortality of the affluent market is 30% less than that of the generally insured public.
• The affluent market keeps policies in force 60% longer than the generally insured public.
• The average policy size of the affluent market is seven times greater than the generally insured public.
This led to institutional pricing for the affluent market that was superior to the retail products available to the general public. But these advisors didn’t stop there.
The data gave the advisors unique insight into product profitability. Typically, when product profits exceed expectations, carriers keep the money and create new versions of products with better pricing based on the better mortality. These advisors saw an issue with this and posed a question: Why wouldn’t you reward the current policyholders who created the value?
Rewarding Policyholders
When life insurance companies design a product series, they obviously are looking to make a profit. Whether they achieve this is heavily influenced by the mortality of the insurance pool. If the pool of insured policyholders lives longer than forecast, then the carrier is taking in more premiums over a longer period of time. In addition, the carriers are also subtracting monthly mortality and expense charges from the cash value portion of the policies for longer periods of time. Overall, better mortality results in more profit for the carriers.
When this occurs in the retail market, the carriers keep these excess profits and they may create a new version of the product. This new version will have better pricing since it reflects the newer mortality experience of that particular carrier’s block of business. So policyholders of the new version get the benefit of the more profitable experience generated by policyholders of the previous version. To take advantage of the better pricing, policyholders of the original policy would have to surrender their policy, go through underwriting again (which may be an issue based on changes in health) and buy the new version of the product.
The advisors saw an issue with this and presented a compelling case that a portion of the profits in excess of original projections should be returned to existing policyholders. This return of profits manifests itself in the reduction of costs to the existing policyholder.
We are also seeing persistency bonus credits where policyholders may get as much as a 50-basis-point increase in their return for staying on the carrier’s books for a long period of time. All of this can represent permanent reductions in the internal costs of the products.
The impact of lower charges can be significantly positive for the policyholder. Take the example of a 65-year-old male who obtained an institutional policy in June 1997. The policy was designed to have an 8% net rate of return with a premium outlay of $85,985 for 10 years. During the ensuing years, the policy experienced three cost-of-insurance charge reductions and three reductions in asset-based charges. As a result, the premium was lowered to $74,065 for 10 years—a 14% reduction.
Another way to look at it is instead of needing an 8% net return, the policy needed only a 6.68% net rate of return. This represents a 132 basis point difference. This figure would have significant impact for a family with significant life insurance holdings.
While past experience is no guarantee of future performance, the principals are solidly in place. From the pricing of the product at the outset to the in-force management of an existing policy when even more favorable experience emerges, these advisors established a level of client advocacy that remains unmatched in the life insurance industry.
When evaluating product options, in some instances a wealth management lens can be a good way to view your life insurance portfolio—particularly when issues of efficiency and effectiveness are important to a family. Affluent individuals can take advantage of their socio-economic demographics to join a risk pool with an opportunity to participate in future mortality gains and expense reductions. As we have seen, sometimes the return of these basis points can have an important influence on the performance of the policies. This is critical when considering the various factors affluent families evaluate when purchasing life insurance. Given the opportunity, affluent families often, if not always, want the opportunity to chase those basis points.
