#63 | Managing a Shadow Account Conversation

A year or so ago, I worked on a case with a producer on an extremely successful financier with three degrees from Harvard, one of which was a JD. All went well and the producer placed a large Guaranteed SUL product. A week or so later, the client called and demanded an explanation as to why the policy contract itself did not specify that his premium was guaranteed. He more or less accused us of lying to him and wanted to terminate the contract under the free-look provision. He had read the contract and it made no sense to him. He wanted to clearly understand the obligation of the life insurer and nowhere did the contract say, even in Harvard English, what the carrier had agreed to do or not do in terms of the guarantee. We had a subsequent phone call where I walked him through the contract line-by-line. He got comfortable with the product and decided to keep it, but it was a close call that I won’t forget.

More importantly, I learned a valuable lesson. We all placed Guaranteed UL products with abandon that operate off of shadow accounts. Understanding those shadow accounts will be an essential part to the long-term administration of Guaranteed UL policies. It’s a language you’ll probably have to speak. So here’s a quick and dirty guide to managing a shadow account conversation. If you want more information on the history of shadow accounts and specific product provisions, you can find it in the following posts: The GUL Trojan HorseFollow Up to The GUL Trojan HorseGUL – Still Not What You Think, Unintended Consequences in GUL AdministrationAG38 Q&A.

Where can I find shadow account information?

Shadow accounts are always outlined in one of two places in the policy contract – either in the specifications section at the front of the policy or in the riders section, usually in the back of the contract. Some policies embed the guarantee in the structure of the policy and others strap it on a base UL chassis as a rider. In either case, virtually all GUL products have information about policy charges that have nothing to do with the guarantee. Don’t let those pages distract you. They’re meaningless because most GUL products have no cash value and therefore the cash charges and credits do not impact whether or not the policy is in-force.

What should I be looking for?

Shadow accounts are comprised of three elements – charges, credits and special provisions. All three are guaranteed not to change. The Cost of Insurance charges will be a schedule that runs in vertical columns just like an illustration. The other charges (premium loads and fixed charges) and the credits will be specified either as a schedule (if they change over time) or stated in the spec section. Special provisions, such as penalties for decreasing the death benefit or underfunding, will usually be in the text. The bulk of the pages will deal with the precise calculation of the shadow account credits. Virtually all GUL products use the same calculation methods as a normal UL (charges out, credits in), but you should read the text to see where the special provisions can hit. Anything more than a single set of policy charges or credits should be viewed with suspicion.

What do I do once I’ve found it?

If your policy contract is clean (meaning that it has no extra schedules of charges), then discussing it with a client is fairly straightforward. The shadow account is a notional value that exists only to determine whether or not the contract is in-force. It does not have any liquid value. Policy charges are deducted and credits are applied. The contract should have more or less performed as illustrated or deviated logically if the premium stream changed. If your contract is dirty, then you’ll need to do more due diligence to make sure the additional charges, credits or special provisions haven’t been triggered in a way that would push the policy from the original plan. The most common cause is deviation from the original premium flow.

What will the carrier give me?

Some carriers like to talk about their shadow account structure as if it’s proprietary data but it’s obviously not since it’s in your contract. If you have a problem with the contract, ask for three things: an in-force ledger, a premium payment history and a monthly (or annual) shadow account value report. They’re probably going to be less than willing to give you the shadow account report, but push hard enough and you’ll get one. It’s not private information and is an essential part of maintaining the policy because it shows the value of the shadow account over the life of the product and will tell you if/when the policy deviated from the original plan. Some carriers like Pacific Life actually put the shadow account value on the annual statement and are less close minded when it comes to divulging the values.

What kind of flexibility does a shadow account offer?

Shadow accounts are bittersweet. On one hand, many carriers used them to essentially cheat on their reserves by baking an extremely high amount of complexity that will severely penalize clients if they deviate from the original plan. On the other hand, shadow accounts provide far more flexibility than an old-school cumulative premium guarantee design.  As long as the shadow account is simple, the client can change the premium stream and fiddle with decreasing the death benefit to make sure the policy still does what he wants it to do. If the shadow account is clean, then any client would much rather have the guarantee provided through a shadow account than a stated premium requirement. This point is what changed the mind of our Harvard educated client. He originally saw the shadow account as unnecessary complexity until he realized that it actually gave the policy extra flexibility for changes in the future.

My advice is not to shy away from a shadow account conversation. If you’re selling a clean one and the client can understand basically how it works, they’ll have a new appreciation for what the product can do for them and be better able to make decisions in the future about how the manage the contract. If you work with estate planning attorneys and trust officers, talking about shadow accounts both in new and old contracts can be a competitive advantage. Chances are good that they don’t have a comprehensive understanding or appreciation of how shadow accounts will impact the long-term outcomes for clients and how their mechanics can be potentially used to the client’s advantage.