#8 | The In-Force NLG Opportunity
Depending on who you ask, roughly 40% of new premium in the life insurance business isn’t really new at all – it’s just been shuffled from an old product to a new product via a tax-free 1035 exchange. Evolution in product design, improvements in mortality, past offenses in sales practices (a la VUL and CAUL at 12%) and changing client needs are all legitimate reasons to switch out an old product for a new one. No Lapse Guarantee products provide an ideal exchange option because they are priced to provide the biggest death benefit bang for premium buck on a guaranteed basis, theoretically eliminating the risk of underperformance. NLG products have soaked up literally hundreds of millions if not billions of dollars of in-force cash value since their inception 12 years ago.
I say “soaked up” for a reason. NLG policies are designed to strangle cash value growth and do it superbly well. A 1035 exchange might only retain 70% of its value in the first year and fall off thereafter. The theory goes that losing cash value in an NLG product isn’t a problem because you’ll never need to exchange it. I’m not so sure. Rising interest rates could present many new, enticing product options just like NLG did for in-force contracts. A policyholder might want to move to a new carrier if his current one has problems. Mortality improvements across the board might result in wholesale price declines, which have happened fairly consistently for a long time. Believing that an NLG product will never need to be exchanged is basically the same as believing that life insurance carriers won’t innovate, interest rates won’t go up and mortality improvements will cease. I’m willing to bet that most people would only put money down on one of those.
So what are we supposed to do with all of these NLG products that could very well be antiquated in 10 years, just as their predecessors were? No cash means no exchanges. No cash means clients losing 40-80% more upon surrender than they would have had they only bought term insurance. No cash means no flexibility, right?
Actually, in-force NLG products are quite flexible even if they have no cash value. NLG pricing is built on a shadow account that functions identically to a traditional UL account value, albeit with some funky pricing metrics. The simple fact the policy is in-force means that the shadow account has value even if the cash value is zero because otherwise the policy would lapse. The shadow account drives the performance of the policy and maintains the guarantee. It’s value locked up in an intangible, invisible vault. The carrier would love for clients to do the most irrational thing in the world – surrender a policy with little or no tangible value so that the massive stores of intangible values in the shadow account will also be forfeited.
Accessing the intangible shadow account value comes in two flavors. First, the client can simply quit paying premiums and let the shadow account value bleed off. Some of the older NLG policies might provide, say, 10-20 years of coverage after only 5 premium payments. The second option, face reduction, is much more interesting and applicable. Many carriers didn’t price their shadow accounts to penalize face reductions via pro-rata surrender charges or fat fixed charges that stay constant regardless of the face amount. The effect is that a client can drop the death benefit to a reduced, paid-up amount without taking a major hit in efficiency. Or, put differently, the difference in IRR between selling a 10 pay when the policy was issued and paying 10 level pay premiums and dropping the face in the 10th year is no worse than the penalty a surrender charge would incur. The agent can write coverage for the difference between the original face and the new, reduced face. It’s a 1035 exchange without the exchange.
Developing expertise in managing NLG policies could pay dividends for producers and brokerages. Every product presents a different set of pricing constraints that were totally unknown to the producer when the product was sold. Managing it takes an expertise separate and apart from selling it. The market is a textbook opportunity – billions of dollars trapped complex products understood by few but owned by many. Whoever can crack the code on putting in-force policies to their highest and best use will have a captive audience of agents who desperately need expertise that they don’t have. Selling a product is one thing, reverse engineering it to maximize its efficiency after the fact is quite another.
In the interim, my advice to agents is to explore every option possible before surrendering a No Lapse Guarantee policy. Chances are very good that the value locked up in the intangible shadow account is far greater than whatever is released upon surrender. I recently worked on a case where an older client had paid the first year’s premium of a million dollars into an uncompetitive NLG product. There was no cash value. We showed an alternative design with much more efficient ongoing premiums. One of the sticking points was that the current policy had “sunk cost” for which the client received nothing. We asked the carrier for a revised in-force illustration showing the guaranteed paid-up death benefit to age 100. The answer? Just over $2 million. So he received double his money back plus a lower ongoing premium stream. It doesn’t always work out this well, but the results when it does are usually quite com