Vol 9 No 3		March 2007

Katt & Company is a national fee-only life insurance advising firm. The June 2002 Forbes magazine, and a July 16, 2003 Wall Street Journal article, name Peter Katt as one of only four nationally recognized advisors. The Forbes article states that, "…advisers are well worth the money… These savants are working for no one but you…" For references please contact us.

Commentary and Rejoinder

Comment on Index UL

The new version of misleading illustrations is index universal life. Index refers to illustrated and policy interest crediting rates that are determined by reference to the S & P 500 Index… I think it is more likely that index UL is nothing more than a marketing gimmick used to justify illustrating much higher interest crediting rates than a company's investments can possibly support in order to achieve a competitive advantage. It is a mystery how index ULs, with the mirage of much higher illustrated crediting rates, are in compliance with illustration regulations.

Misleading life insurance illustrations are back and buyers are again being subjected to policy performance promises that are quite unlikely to be realized. A major type of permanent life insurance is what I refer to as market-priced. Future performance depends on future interest rates and to a lesser degree future mortality experience. During the late 1980s and 1990s many companies used illustration gimmicks to make their policies appear to have fewer premiums or create higher values than their current pricing could provide. Among the common techniques used: using bonus interest in five or 10 years; lapse-supported pricing; and return of mortality costs after 10 or 20 years. These illustration wars were such a problem that the industry finally was able to promulgate model regulations for life insurance illustrations in 2001. Under the regulations, interest rates embedded into the illustrations are not supposed to be "…greater than the earned interest rate underlying the disciplined current scale." The disciplined current scale requires insurers to use non-guaranteed elements that are "…reasonably based on actual recent historical experience…"

The new version of misleading illustrations is index universal life. Index refers to illustrated and policy interest crediting rates that are determined by reference to the S & P 500 Index. I have seen illustrated rates as high as 8.2% that also included an illustrated 0.5% bonus rate starting in the 11th policy year. The problem is that index premiums are not being invested in the S & P 500. One investment portfolio I reviewed contained 96% fixed income instruments. The sellers of index UL claim they are able to provide such high returns, with typically 3% guarantees, by buying various stock options to cover the larger returns. Color me skeptical. Even if companies have actually designed hedging formulas, such exotic strategies are notoriously inaccurate. The bust of sub-prime lending practices being the most recent example of how financial wizards are able to outsmart themselves.

I think it is more likely that index UL is nothing more than a marketing gimmick used to justify illustrating much higher interest crediting rates than a company's investments can possibly support in order to achieve a competitive advantage. Sales pitches of 10% and 11% crediting are backed up by such contract language as, "…the annual index growth that will be recognized in the calculation of the index earnings for an equity indexed segment on a segment anniversary. We will determine in advance the participation rate applicable to each equity indexed segment for each twelve month period and will communicate it to you in an annual report or in notices to you." HUH? This means the insurance company can credit whatever they want above the very modest guarantees. In addition, because most index UL's allow the insurance company to increase cost-of-insurance at any time, a higher crediting rate may not mean anything at all, because it can be offset by higher COIs.

It is a mystery how index ULs with the mirage of much higher illustrated crediting rates are in compliance with illustration regulations.

I am not suggesting that index ULs will necessarily perform below conventional market-priced UL or whole life, just don’t believe that they will provide superior performance because the illustrations look better.

Rejoinder to Leimberg's 412(i) Newsletter

Steve Leimberg publishes a useful and often informative email newsletter dealing with a myriad of tax and financial product issues (http://www.leimbergservices.com). He sometimes offers up commentary from various sources about life insurance that often carry considerable baggage for the industry and its agents, such as the infamous 419 plans. Though Mr. Leimberg hasn't welcomed my observations about these commentaries I have grown weary of reading pieces, in my area of expertise, from life insurance sellers and marketers whose biased views do not provide critical judgments.

Leimberg's March 14, 2007 newsletter features a 40 year life insurance veteran giving a soup-to-nuts commentary on 412(i) plans. While noting that there have been abusive 412(i) plans (mostly utilizing springing cash values for tax avoidance that regulations under 402(a) have crushed - see Life INSURANCE PERSPECTIVES Vol. 9, No. 1) it treats life insurance funding as perfectly fine and an effective tool. I disagree. 412(i)s funded in part with life insurance should usually be avoided. 412(i)s are popular with sellers precisely because of the very high commissions received for the life insurance funding that often makes up 50% of the contributions. Life insurance commissions are often 70% of the contribution, while annuity commissions are usually around 3%. See Life INSURANCE PERSPECTIVE Vol. 8, No. 6. The 412(i) referred to in this Perspective was sold by one of the nations largest banks, and I believe it is typical of 412(i) sales. Since issuing this Perspective I have heard from several attorneys that attended 412(i) seminars confirming my experience that most sellers of 412(i) plans always try to stuff them with life insurance. This is why they should mostly be avoided.