Understanding Life Insurance Illustrations: A Beginner's Guide

A life insurance illustration is a document that outlines the details of a life insurance policy to help potential policyholders understand how the policy works, its benefits, and how premiums are structured. It is a hypothetical ledger that shows how a life insurance policy might perform under different circumstances and outcomes. The illustration is based on several assumptions about the policyholder and macroeconomic forecasts such as interest rates. It is a powerful tool for analyzing and comparing the utility of different types of policies for particular individual situations.

The purpose of a life insurance illustration

Life insurance illustrations are particularly useful for permanent life insurance policies, which can be confusing due to the wide variety of options available, including term, whole, universal, and variable life policies. These illustrations allow prospective policyholders to compare different policies and make an informed decision about which type of policy is best suited to their needs.

The illustration will typically include information such as the type of life insurance, the policyholder's age and health-related information, the amount and frequency of premium payments, the death benefit, cash value, guaranteed and non-guaranteed values, policy loans and withdrawals, policy riders, policy exclusions and limitations, and assumptions about future inflation and interest rates.

It's important to note that a life insurance illustration is not a guarantee of future performance. The non-guaranteed values are based on assumptions that may not hold true, and actual policy results can vary. However, it serves as a helpful tool for understanding the potential growth and benefits of a life insurance policy, especially for those who are visual learners.

What a life insurance illustration illustrates

A life insurance illustration is a document that outlines the details of a life insurance policy to help potential policyholders understand how the policy works, its benefits, and how premiums are structured. It is a hypothetical ledger that shows how a life insurance policy might perform under different circumstances and outcomes. The illustration can be 15-20 pages long, with dense text and legal disclaimers, and follows a general format and guidelines established by regulators.

The illustration will show the expected costs and benefits related to the policy, based on several assumptions about the policyholder and macroeconomic forecasts such as interest rates. It will include the type of life insurance (e.g. term, whole life, universal life), the policyholder's age and health-related information, the amount and frequency of premium payments, the death benefit, and the cash value.

The illustration will also include information on policy loans and withdrawals, policy riders, policy exclusions and limitations, and inflation and interest rate assumptions. It is important to note that a life insurance illustration is not a guarantee of future performance, and actual policy results can vary.

The guaranteed illustration is a legally required disclosure of a worst-case scenario, outlining policy performance based on the carrier's minimum credit rates and maximum mortality charges. The current illustration represents the insurer's policy performance based on credit rates and mortality charges currently in effect.

Life insurance illustrations are created using specialized software provided by insurance companies, which uses a set of assumptions to project future policy values, including interest rates, dividend rates, mortality rates, expense charges, and administrative fees.

How to read a life insurance illustration

A life insurance illustration is a document that estimates how an insurance policy will perform over the course of its coverage. It is a hypothetical ledger that can be up to 15-20 pages of complex text, outlining the expected costs and benefits of the policy. Here's how to read one:

Check Your Variables

The first few pages of the illustration contain an explanation of the coverage, terms, and definitions. Verify that your variables, such as your rating, age, and payment plan, are correct. Also, check the riders, premium, and whether the policy has a level or increasing death benefit.

Understand the Fees and Expenses

Review the current and maximum policy fees and expenses, as well as the minimum guaranteed and current interest or dividend rates. These factors can impact the overall cost of the policy.

Read the Ledger or Table

Look for a ledger or table that illustrates how the policy could perform under different scenarios. It will usually be labelled "guaranteed" (worst-case scenario) and "nonguaranteed" (best-case and most likely scenarios). These ledgers will show how the policy performs in five-year increments, based on different fee and interest rate structures.

Examine the Rate of Return Assumptions

Consider your risk tolerance when reviewing the ledgers. Think about the potential impact of aggressive returns or low-interest rates on your premium payments and policy performance.

Understand the Benefits and Premiums

Review the benefits entitled to the policyholder and the premiums required to maintain those benefits. This will help you understand the value you are getting from the policy and the cost of maintaining that value.

Review Supplemental Illustrations

In addition to the basic illustration, there may be supplemental illustrations that provide additional details on the non-guaranteed elements of the policy. These can offer further insights into how the policy may perform.

Seek Clarification

If you have any questions or concerns about the illustration, don't hesitate to reach out to your insurance agent or broker. They can provide additional information and help you make an informed decision about the policy.

How life insurance illustrations are created

A life insurance illustration is a document that estimates how an insurance policy will perform over the course of its coverage. Illustrations are used to inform potential policyholders and help insurance agents in their sales process.

To create a life insurance illustration, an agent enters different variables into a software program developed by the insurer. These variables include:

• Age
• Health rating
• Family medical history
• Payment plan
• Assumed rate of return
• Age at the end of the policy

These variables help the software calculate the following:

• Cost of insurance
• Policy charges
• Expenses
• Riders
• Planned or target premium

The illustration will depict expected costs and benefits related to the policy, based on several assumptions about the policyholder and macroeconomic forecasts such as interest rates.

There are three types of life insurance illustrations:

• Basic illustration: Used in the marketing of the policy, it shows both guaranteed and non-guaranteed elements.
• Supplemental illustration: Depicts only the non-guaranteed elements permitted in the basic illustration.
• In-force illustration: Periodic updates on the policy's performance that can be provided by the company or requested by the policy owner after the first policy anniversary.

Life insurance illustration regulations

Life insurance illustrations are subject to regulations that ensure consumers receive accurate and transparent information about the features and benefits of life insurance policies. These regulations are designed to protect consumers and foster consumer education, providing a clear understanding of the policy's performance, benefits, premiums, expenses, and other key elements. Here is an overview of some key life insurance illustration regulations:

Life Insurance Illustrations Model Regulation (#582)

The Life Insurance Illustrations Model Regulation (#582) provides rules for life insurance policy illustrations, aiming to protect consumers and promote consumer education. It is applicable to group and individual life insurance policies with illustrated death benefits exceeding $10,000, excluding variable life insurance, credit life insurance contracts, and annuities. This model allows insurers to choose whether to market a policy with an illustration and defines three types of illustrations: basic, supplemental, and in-force.

AG 49B

AG 49B is a regulatory guideline issued by the National Association of Insurance Commissioners (NAIC) to address concerns about potentially misleading indexed universal life insurance (IUL) policy illustrations. It establishes uniform standards and prevents insurers from projecting unrealistically high policy performance through specific bonuses or multipliers, ensuring greater consistency and transparency.

State Insurance Departments

While the NAIC provides model regulations, individual state insurance departments regulate insurance practices within their respective states. They often adopt and modify NAIC models to suit their specific requirements and enforce compliance with these regulations.

Regulation Best Interest (Reg BI)

Implemented by the U.S. Securities and Exchange Commission (SEC), Reg BI mandates that recommendations be in the client's best interest and that any conflicts of interest are disclosed. This regulation ensures that clients receive advice and recommendations that align with their financial goals and risk tolerance.

These regulations work together to ensure that life insurance illustrations are accurate, transparent, and not misleading. They provide consumers with a clear understanding of the policy's performance, benefits, and financial projections, enabling them to make informed decisions about their life insurance choices.

Frequently asked questions