#78 | PacLife PDX – Part 3 – The Hidden Performance Factor

This post delves deep into the mechanics of PDX and goes far beyond anything PacLife has written about the product. I’ve spent a significant amount of time, to use an analogy, feeling out the shape of a statue in a very dark room. I fully recognize that the statue might look different with the lights flipped on – should PacLife, or anyone else, turn on the lights and provide more insight into PDX, I would welcome the information as an addition to public discourse on PDX and would correct or amend my analysis, if warranted.

PDX is built on top of PIPLT II which in turn was built on top of PIPLT, one of the first IUL products that had a bonus on indexed credits. PIPLT’s basic value proposition was that it had higher charges in policy years 1-10 than PacLife’s longstanding flagship IUL, Pacific Indexed Accumulator (PIA), but also offered a persistency bonus beginning in policy year 11. Policyholders who lapse early have paid higher policy charges than in PIA but policyholders who stick around get bonus interest.

The innovation in PIPLT was that the bonus could either be earned as additional stated interest in the Fixed Account or as a credit multiplier in the indexed account. In either flavor, the bonus was paid from year 11 to the greater of year 20 or age 70. For example, any person 50 years old or greater would earn an additional 1% from years 11-20 (age 70) in the Fixed Account or a multiplier of 23% (1.23) in the indexed accounts. For a 35 year old, the bonus period is obviously quite a bit longer and therefore the bonuses are lower, just 0.38% in the Fixed Account and an 8.91% multiplier in the indexed account. PIPLT sold like hotcakes because it illustrates quite well thanks to the multiplier. The dollar amount of the higher charges were always less than the dollar benefits of the bonus. In the strange world of life insurance, it’s a fair trade for persistency.

Because the PDX charge chassis is identical to PIPLT except for charges that go directly into the MX portion of the Performance Factor, it would be logical to assume that the persistency bonus structure from PIPLT carried over into the Performance Factor in PDX. But, in a strange twist, it doesn’t. Because there’s no documentation from PacLife about the Performance Factor formula, you’re left to derive the persistency piece of the Performance Factor, which I’ll call QX, on your own.  The only way to isolate QX is to reverse engineer what the Performance Factor should be based only on MX and compare it to the actual Performance Factor. The difference between the calculated MX and the actual credited Performance Factor is the QX.

Once you know QX is there, then it’s fairly easy to see what appears to be its structure. Whereas PIPLT’s persistency bonus goes from year 11 to the later of year 20 or age 70, QX in PDX always goes from policy year 11 to year 35. And whereas PIPLT’s persistency bonus is always a flat rate throughout the payout period, QX in PDX pays a different amount each year. The shape of QX is like a shark fin – it gradually increases until it peaks in year 30 and then rapidly drops off from year 31 until it disappears at year 35. The chart below shows QX figures for 5 ages (35, 45, 55, 65 and 75) over time. You can see the clearly defined shark fin shape and uniform payout period.

The table below walks through QX, MX and the total Performance Factor for 5 ages – 35, 45, 55, 65 and 75. MX is calculated based on 6 maximum non-MEC premiums and an illustrated rate of 6%. QX is obviously constant across all funding patterns because it is funded via the policy charges in the first 10 years only, just like in PIPLT.

Another way to look at the impact of QX is to translate its values into its impact on the illustrated rate. Because QX is delivered to the policyholder in the form of a multiplier, you can back into the illustrated benefit of QX by just multiplying the illustrated rate by the QX factor plus 1. The table below translates the numbers above into illustrated rate impact, assuming the default AG49 6.17% illustrated rate in PDX.

As you can see, QX itself delivers a significant portion of the illustrated performance of PDX, particularly in later years – far more than the persistency bonus contributes to PIPLT’s performance. Mathematically, QX should have the same value as the persistency bonus structure of PIPLT because the charges to fund the bonus are identical. But the fact that QX has a different structure than the persistency bonus in PIPLT is a hint that there might be more to the story. PIPLT’s persistency bonus is a fairly straightforward tradeoff. There are finite extra policy charges that go to fund a finite bonus that directly relates to the payout period. For example, all policyholders with a 10 year bonus period in PIPLT get the same bonus.

But QX in PDX doesn’t work that way – it introduces more variables. The older the policyholder, the bigger the bonuses. Differences in lapse rates at different ages can’t explain the huge variances in QX at different age bands. But mortality does. By stretching QX out for 35 years regardless of the initial age of the client, PacLife can discount back its anticipated payouts of QX not just by persistency, but also by mortality. To put it bluntly, the vast majority of 75 year olds will be dead by the time QX peaks at year 30. That allows PacLife to project huge QX bonuses that have very little actual value, in hard dollars, once you adjust for the fact that very few 75 year olds will be alive to get the bonuses. The vast majority of 45 year olds, on the other hand, will still be alive after 30 years. The sheer dollar amount available to pay future QX bonuses is proportionally the same in both cases, but thanks to mortality, it’s spread over far fewer policyholders for 75 year olds than 45 year olds. Therefore, individual 75 year olds who make it to year 30 get bigger bonuses than individual 45 year olds who make it to year 30, even if the total amount across the entire population is the same. That’s the magic of discounting future benefits by mortality. It’s not exactly a new idea, as you’ll see in the next post, but it does have some profound and important implications.