No, I am not sending you to the doctor today. I am, however, recommending that we put our designs under stress before we present them to the client. Why? Simple – things change. Take the recent 2012 dividend announcement from Northwestern Mutual as an example. It was reduced from 6.00% to 5.85%. This reduction, right around 2.5%, does not seem newsworthy at first glance. Looking a little deeper may tell a different story.
Depending on when a Northwestern policy was issued, this may not be the first reduction the policy will have to absorb. Unlike the general public, who may think that whole life is a conservative play, we know that it can rely heavily on dividend performance in certain designs. The question then becomes how much of a dividend reduction can a particular policy handle before the future viability of that policy is in jeopardy? Very, very few agents know the answer to that question, and that is a problem.
Northwestern is certainly not alone in this. Any policy that is reliant upon non-guaranteed elements is subject to reduced dividend, interest rate or market performance. Based upon the history of our industry, a reduction from current projections is not only possible, but likely. The question becomes how do we guide our clients through the selection and management of their policy over time? Time to put that policy on the treadmill, attach a bunch of leads, and make it run for its life!
So how do we do that? Try to “break” the design. Identifying the failure point in a given design is the goal. What do I mean by failure point? Essentially, it is when the policy can no longer accomplish the goals we identified at the time of the sale. Examples:
- Premature policy lapse
- Extension of the original premium payment period
- Significantly reduced accumulation or income potential
- Under performance versus currently available products
The good news is that there are some products that are immune to this – GUL funded to guarantee to maturity, or Whole Life designs that are fully guaranteed for instance – but the list of contracts that are subject to failure contains virtually every other permanent product.
So how do we break the design? The easiest way is to reduce the appropriate metric to the point the design no longer makes sense. If we look at the first three items on the list above, we can reduce the assumed rate to the point that any of those three scenarios result. Note that rate in the file. If the margin for error is too small at policy inception, it is probably time to change the design. Once a policy is in force, if future reductions or actual experience approach that rate, it may be time to go shopping for a new policy. Of course, the timing of these reductions plays a large part as well, which leads us to the dead horse that is the annual review. Reviews are the annual check-up that go along with the stress test analogy.
If we are all on the same page at this point, the question in my mind is how does it impact our work with clients? I see a few impacts:
- Better informed clients, who may have a better handle on what they are actually buying.
- A reinforcement of why this is an asset that needs to managed like any other.
- Exposure of designs that should never see the light of day, because the margin for error is so slim.
- More realistic client expectations.
- Separation of the agent from policy performance
- More satisfied policy owners
Sure, you may have some clients elect to go in a different direction once they have this level of understanding. From my perspective, those very same clients would end up the unhappy ones if they had moved forward without this understanding. Go ahead and give me a call if you need some help stress testing your next case.