What are reasonable interest assumptions for Whole Life plans?

Participating whole life (par) insurance is similar to universal life in the sense that it too contains a tax-deferred cash value accumulation. However, unlike universal life, the company manages the investment portion in a diversified portfolio called the participating account (par account) that is invested primarily in bonds, mortgages, equities and real estate.

 

Par policies are built on a foundation of guaranteed values based on long-term conservative assumptions for investment returns, mortality, expenses, and other relevant factors. Collectively, these assumptions form the guaranteed premiums, death benefits and guaranteed cash surrender values.

 

If the actual results in the par account are collectively more favourable than the assumptions supporting the guaranteed values, there will be a surplus in the par account. A portion of this surplus is paid to par policy owners as dividends. Par illustrations contain assumptions around the amount of dividends that will be credited to the policy each year.

 

It's important that, as with universal life illustrations, the assumptions used are reasonable.

 

How do I identify reasonable assumptions?

 

The good news is that you don't get to pick the assumptions, nor can your financial advisor. The assumptions are made by the company issuing the policy.

 

Ok, whether that's good news or not is debatable. Although we have no control over the assumptions, we can at least identify the companies assumptions and determine to see whether or not they are in line with what is in fact "reasonable."

 

One of the key issues that must be examined is the company's historical performance. Using these facts, a solid company with sound financials is more likely to illustrate a more "attractive" illustration. Consequently it is vital to first examine the financial strength of the company in question before proceeding any further. Clicking here will take you to an excellent article that can help you identify which companies to consider, and which ones to stay clear from.

 

The calculations and formulas used to determine the reasonable assumptions are beyond the scope of this discussion. However, it is sufficient to state that the company's historical performance should be examined, and this data should be available to all upon request.

 

For instance, a company should be doing the following:

• Looking back at multiple 30-year periods starting as early as 1945-1955 and analysing the performance of a sample of policies issued since then with moderate death benefits.
• Calculating the effective annual returns earned on the premiums paid.
• Calculating the cash surrender value available at the end of 30 years.

If this doesn't make a lot of sense, don't worry. Ask the following questions to your financial advisor:

• What was the highest 30-year compound annual return for the last 30 years?
• What was the lowest (this can indicate their strength during troubled economic times)?
• What was the median? (not the average!)

For example, a company could have had a high of 10.0% and a low of 4.5% with a median of 6.5%. The dividend scale assumption should not exceed the historical median result.

 

As with universal life, it is important to receive an alternate or reduced scenario illustration to gain insights into the sensitivity of a change in the dividend scale assumption.

 

Now proceed to the next page to review all the traps you must avoid!

 

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Summary of life insurance traps to avoid.

 

 

 

Click a link below to jump to another section of the article:

 

What is the purpose of life insurance illustrations?

 

What is a reasonable period of time an illustration should consider?

 

How does the interest rate chosen make a significant difference in investment returns?

 

What are reasonable interest assumptions for Universal Life plans?

 

How should I consider interest bonuses?

 

Contact a professional broker for your free consultation.

 

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