#88 | PacLife PDX – Post 9 – In Closing
When I started writing about PDX, I had absolutely no idea that it would take 9 posts and 16,000 words to unpack it. Writing each post was like walking into a room with a hidden passage that can only be discovered after exploring every little dark corner of the room. And once you find the passage, you have to walk through it to explore the next room and find the next passage. Hence, 7 posts that I honestly believe are essential to understanding this product and that I could not have left out. And there are still some hidden passages that I can see but can’t walk down. I know that there’s a formula for the QX Factor but I don’t know what it is. I know that PacLife calibrated the charges in PDX to the Guideline Level Premium, but I don’t know how they came up what percentage of GLP to use. These are questions that, in the final reckoning, can be left unanswered. They just are what they are.
In this post, I’m going to draw some final factual conclusions and then opine a bit on PDX and what it means for Indexed UL and our industry. Up until this point, I’ve really tried to stick to the facts and keep my opinion out of the discussion. But I’ve had enough people ask me what I really think about PDX that I might as well write it out.
Now, for the facts. It is irrefutable that PDX is single most complex life insurance product on the market. If you look up “complexity” in the dictionary, the first definition is that complexity is something with many different and interconnected parts. PDX has many complicated factors, but what makes PDX complex is the way that all of these complicated factors interconnect and play off of one another. It is very difficult, if not impossible, to generalize about PDX. The PDX that you see in the illustration is a function of the age of the client, the funding pattern, the illustrated rate and the face option, for starters. You’ll see a different PDX with different inputs. PDX brings to mind the old fable of the blind men touching an elephant. One man grabs a trunk and says “an elephant is like a rope.” Another man touches the side and says “an elephant is like a wall.” Another man feels the leg and says “an elephant is like a tree.” In the world of PDX, we’re the blind men grabbing different pieces of the product and trying to make generalizations. Do so at your own peril.
The second part of the dictionary definition for complexity really made me chuckle – denoting or involving numbers or quantities containing both a real and imaginary* part. This, too, rings true for PDX. The “real” part of PDX is the basic mechanics of the MX Factor and the undeniable fact that PacLife plans to the high policy charges in PDX to buy more options and deliver the returns in the form of the Performance Factor. The “imaginary” part of PDX is the QX Factor, which appears more or less out of thin air without a hint of disclosure but dominates illustrated performance. This is a very fitting categorization because, in math, you can’t really get rid of imaginary numbers once they enter your equation. I remember struggling with imaginary numbers in school and just wishing that I could get rid of them or at least ignore them. But, unfortunately, I could do neither. And it’s the same with QX. Lots of people would like to just ignore it or get rid of it, but the simple fact about PDX is that QX is more important to the illustrated performance of the product than MX. If you’re selling PDX, you’re really selling QX. You think you’re selling 1+1 = 2, but you’re really selling 1+1i = 1+i. Sorry, that imaginary number is still in there, whether you like it or not, and it completely changes the result.
Both of these two facts lead up to another irrefutable fact about PDX – PacLife has done about as much disclosure on the Performance Factor as autocratic dictators do when they count the votes. I know, for a fact, that there are people at PacLife who would like to say much more than they’ve been able to say about how PDX works and actually kind of appreciate the fact that I’ve worked through the product mechanics in such excruciating detail because they can’t. Why not? Well, because disclosing how a non-guaranteed, extra-contractual formula that can change at any time works doesn’t make much sense to the lawyers and compliance people at PacLife. How can you disclose the inner workings of an extra-contractual formula that you aren’t committing yourself to follow? A formula that the policyholder and producer will never actually know is being followed or not because it has so many inputs? A formula that has so many moving parts that even minor adjustments in ratios can dramatically change the outcomes? For my part, given what I know about the formula itself and drawing from my experience working at a major insurance company, I think the lawyers are right on this one. PacLife put itself in an untenable position for disclosure on PDX. In any UL, there are lots of non-guaranteed elements that exist within the contractually guaranteed mechanics of the policy. But with PDX, the Performance Factor formula is based on non-guaranteed elements that operate within extra-contractual, non-guaranteed mechanics. It’s just a bridge too far for disclosure. My hope is that the next iterations of the Performance Factor in future PacLife products will have guaranteed mechanics, much in the same way that John Hancock moved from a non-guaranteed, non-disclosed formula for the all-important Persistency Credit in the original Protection UL in 2011 to a guaranteed and disclosed formula in subsequent versions.
But until then, we are left with the final irrefutable fact about PDX – the policy charges in PDX are the highest of any life insurance product in the industry, bar none. High policy charges always add more sequence of return risk to a life insurance policy and PDX is absolutely stuffed to the gills with it. The high charges in PDX also undermine the basic story of Indexed UL that the client isn’t exposed when the market goes down because the base charges in PDX can eat up 5% or more of the account value even in a fully funded product. But the biggest problem with the high charges in PDX is although that the charges are clear and certain, the benefits supposedly derived from those charges and delivered in the form of the Performance Factor are anything but clear and certain. There is an asymmetry between the costs and benefit sides of the Performance Factor equation. The costs are set in stone, the benefits are written in pencil.
These are the irrefutable facts. Do with them what you will. But, for me, these facts basically preclude me from being able to recommend PDX to anyone under pretty much any circumstance. Not because I think PDX will perform worse than other IUL products, because it probably won’t. Not because PDX the charges in PDX make it an inherently riskier product, because that can be managed. No, the reason why I can’t ever recommend PDX is because it’s simply too complex, with too many comingled real and imaginary parts. I don’t think I’m overstating when I say that, after all of the research I’ve done to write the 25 pages of this PDX review, I probably know more about PDX than anyone who isn’t an actuary at Pacific Life – and I don’t feel comfortable that I could sit down with a real client every year for the next 20 years and explain, even generically, why that client got a particular Performance Factor in any particular year. This is an insurmountable problem for me. You could say the same issue exists in any life insurance policy when it comes to dividends or crediting rates, but let’s be real. Those policies aren’t making an explicit tradeoff between ultra-high policy charges and crediting benefits. Every year, with PDX, I would be able to point directly to the charges but I would not be able to explain the benefits. I just can’t sell a product like that.
Beyond that, though, there’s another issue with PDX. The complexities of this product make it easy to miss the forest for trees. At its most basic level, PDX illustrates well simply because it puts more money to work in the options budget. Why is this a winning strategy on the illustration? Because all Indexed UL products show that systematically buying equity call options will result in 50% profits every year, forever. Indexed UL illustrations are a magical machine that transforms any money spent on options into up to 1.5 times that amount in illustrated profit. Normal, socially acceptable IUL products put the general account yield of, let’s say, 4% to work in the 50% annual profit machine. PDX puts something like 6-10% of a fully funded product to work in the 50% annual profit machine. No surprise, then, that PDX illustrates better than other IUL products. But where does this logic stop? If you really had a 50% annual profit machine, why would you limit yourself to 10% of your money? Why not 25%? Why not 50%? Why not all of it?
“Mokita” is a New Guinean word that means “the truth we all know but agree not to talk about.” The mokita in Indexed UL is that everyone knows the 50% options profit machine is a lie. If it were really true, you’d hear and read about this strategy everywhere outside of our dark little corner of financial services, but you don’t. You would see the people selling Indexed UL quitting their jobs to trade options, but you don’t. Hell, if it were true, you could at least find one single, solitary academic study backing up the claim, but you can’t. But to admit that the 50% options profit machine embedded in every IUL illustration is a lie would undermine the core reason for the smashing success of Indexed UL products in recent years. Indexed UL products and the carriers that write them must walk the fine line between illustrating enough performance to win, without drawing attention to the central conceit of the 50% profit machine. PDX crossed the line. It forces the issue. The only reason that every other company won’t follow PDX down the rabbit hole of ever higher charges for ever higher options budgets for ever higher illustrated performance is because of the mokita. To follow PDX would mean jeopardizing the whole franchise.
For me, then, selling any PDX would mean that I believe that the 50% options profit machine is real. That’s the only way this product delivers better results than its peers. But I don’t. I like Indexed UL because it tells a compelling story – upside potential with downside protection. PDX jeopardizes half of the story with the highest policy charges in the industry and casts the other half into doubt with a Performance Factor that is impossible to explain and administer. It essentially sacrifices the story that I like on the altar of the story that sells – maximum illustrated performance, regardless of the risks and complexities in the product. I would much rather sell a product that tells the story I tell in as simple and straightforward of a wrapper as possible, a product like Pacific Life’s classic Pacific Indexed Accumulator 5 (PIA 5). There are so many reasons why I like, respect and want to work with Pacific Life. But if I sell a PacLife Indexed UL product, it’s going to be PIA 5, not PDX.
*yes, math nerds, I know that I’m using the common definition of “imaginary” to make my point when the mathematical definition of an imaginary number is just the square root of -1. The literary device was just too good to pass up. I also just finished a book that finally made imaginary numbers as a phase space construct make sense to me – Chaos: Making a New Science by James Gleick.