#101 | PacLife PDX – Part 10 – Summary & Epilogue
Since wrapping up the PacLife PDX Review series in March with the 9th post, I’ve had a feeling that I’d end up doing one more article on PDX – both as a summary of the full analysis and an epilogue. Overall, the response to the article series has been overwhelmingly positive and proved to me that there is absolutely a need in the life insurance business for someone to write independent and objective reviews of life insurance products.
I learned a few other things along the way as well. Because the full PDX review was necessarily long and technical, some people have understandably conflated the parts where I share my opinions with the objective analysis of the product and have been using the review as a weapon, for lack of a better term, in sales situations. This was never my intent, but I can understand how people could read the highlights and see a more negative picture than I meant to paint. Second, the product reviews on this site are designed for people who can handle the information for what it is – a comprehensive analytical and technical analysis of the product – and are willing to fund future analysis of new products by buying a subscription to the site. I have been immensely disappointed to find out that full copies of my subscriber-only PDX review have been floating around, including one that got into the hands of a major publication that subsequently ran an article on it.
Nonetheless, the sheer fact that people would even bother to steal and distribute the content tells me that there’s a virtually insatiable interest in the topic. As a result, I saw the need for the 10th post on PDX – a simplified, crystallized and short-form public commentary to clarify both the analysis and my position. Not for use as a weapon, but instead for the sake of furthering the conversation about the products we sell and what they say about us and our future.
Why PDX
Simply put, I couldn’t do the first product review on this site about anything other than PacLife PDX. It defined and dominated the Indexed UL market last year and continues to do so this year, attracting plenty of supporters and detractors along the way. PDX is at least as polarizing to the life insurance business as Donald Trump is to the American public – and that’s even without its own Twitter account. And as I dug more into the product, I found that a lot of the conviction on both sides of the house was rooted in misunderstandings, through no fault of their own. PacLife has so little disclosure about how PDX actually works that people have been left to their own devices to make sense of it. That’s why I felt that I had to review it – not to create a weapon against it, but to understand it, to translate it. The fact that doing so took 16,000 words and 28 pages is evidence that it was the right undertaking.
The Simple Story
It is now quite well known that PDX uses an annual fixed policy charge to fund an indexed interest bonus called the Performance Factor. The basic math is quite simple – the fixed charge is quoted as a percentage of the account value, which is then quoted as a percentage of the option budget. That’s your bonus. For example, a $10,000 fixed charge on a $500,000 account value is equal to 2% of the account value. If the option budget for the product is 4.1%, then the bonus is 48.8% (2% / 4.1%). When you hear people say that PDX isn’t really all that complicated, this is the math they’re going to show you. I call this part of the Performance Factor MX and PacLife refers to it internally as Part II. Unfortunately, it’s the smaller part of the real story of how the product does what it does.
The Not-So-Simple Story
If you actually try to calculate the paid Performance Factor from a real illustration using the math above, you’re not going to match the numbers. In fact, you often won’t even get close. You could be off by a factor of 10. Why? Because the Performance Factor is more than just the simple math. It also includes another bonus that isn’t directly funded by the high long-term fixed charges in the product. It just appears like fairydust, as bonuses so often do in Indexed UL products these days. But this fairydust, which I call QX and PacLife calls Part I, is powerful stuff. When you look what part of the Performance Factor is due to MX versus QX, you’ll see that QX makes up about 60% of the Performance Factor. In other words, when you illustrate PacLife PDX, the majority of the illustrated performance of the product comes from QX, not the fixed charge funded bonus that everyone now knows and talks about. Want to know how QX works? Buy a membership to the site because the explanation doesn’t fit into a soundbite. But, needless to say, it’s complicated.
Complexity, Disclosure and PDX
The main problem with PDX presents itself here – everything that I wrote above, all of the hours it took me to accurately derive the mechanics of the Performance Factor to the point where I was confident that I had it right, is a result of the fact that PacLife does virtually zero disclosure on how the Performance Factor works in its formal documents. PacLife has started to do some education about the MX portion, but they’re still pretty hesitant to talk about QX which, as I note above, is the source of the majority of the performance of the product. Why is this a problem? Just imagine having a conversation with a client 5 years from now about their in-force PDX contract. Will you be able to explain whether or not their Performance Factor is fair? Here’s a list of what you need to know in order to do that: the portion of the fixed charge going to fund the bonus (undisclosed), the option budget used to calculate the ratio (undisclosed), the portion of the bonus attributable to QX (undisclosed) and whether or not the fundamental formula for the Performance Factor has changed (undisclosed, non-contractual). That’s the only way to know whether or not the client is getting what they’re supposed to get. And here’s the kicker – the Performance Factor and all of its inputs are going to be different next year, and the next year and every year thereafter. Every year you can look forward to your client asking you whether or not their specific Performance Factor is “fair.” And you’ll never really know. You just have to trust PacLife. I can think of fewer companies that I’d rather trust with something like this, but as I wrote in the original review, people who drive Volvos still wear seatbelts.
The Easy Fix for PDX
PacLife made a significant and strategic error in releasing PDX without disclosing and guaranteeing the mechanics of the Performance Factor. They know this and have practically publicly admitted as much. They made a further error by complicating it with two parts, one that has a nice clean story about where it comes from (MX) and another that is fairydust (QX) without an explanation of its source. I wrote in the full PDX series that I can’t recommend PDX to anyone under any circumstance and a lot of people saw that as an indictment of the product. It’s not. It’s an indictment of the fact that PacLife built a product that illustrates well due to a highly complex mechanism with zero disclosure of how it works. Complexity without disclosure is wholly unacceptable in financial products. How can you possibly do your job as an advisor if you’re selling a highly complex product that you literally cannot explain to your client? That’s why I, personally, would never sell PDX. My conclusion will change the moment that PacLife guarantees the mechanics of the Performance Factor and fully discloses its inputs. Then the question becomes whether or not PDX offers an attractive value proposition for policyholders.
Quantifying Risk and Leverage in PDX
Which, undeniably, it can. No matter what way you slice the numbers, PDX is the riskiest and most leveraged Indexed UL on the market – and I have no idea why people at PacLife think that, in itself, is a derogatory statement. Risk and leverage on an asset that performs well is a good thing, is it not? And since Indexed UL products illustrate consistent 50% option profits forever, why would you not take more risk to get more leverage on an asset class that delivers those kinds of returns? In other words, if you believe that Indexed UL is built on the bedrock of 50% average option profits, then you should love the risk and leverage PDX (excusing, for a moment, the complexity without disclosure issue) because that’s how PDX delivers the goods on the illustration. You should sell as much of it as you can. You should tell your clients to borrow massive amounts of money to buy this product. You should even buy it for yourself.
And, as it turns out, that’s exactly what a lot of agents are doing. They’re selling boatloads of it. They’re telling clients to borrow millions and millions of dollars to buy PDX. They’re writing policies on themselves, their spouses and their kids. They believe that risk and leverage on this asset class that illustrates 50% profits forever is a good thing. PDX wouldn’t be so successful if it wasn’t riskier and more leveraged than other Indexed UL products. That’s why it illustrates so well.
My problem with how risk and leverage manifests in PDX is fourfold. First, PDX delivers its risk and leverage through complex mechanisms without adequate disclosure of the mechanics and inputs. Second, the disclosure of the risk and leverage in all Indexed UL products has not caught up to the attractiveness of the illustrated profits from the risk and leverage. This is only made more obvious in PDX, but it’s a problem for all IUL products. Third, the complexity of the Performance Factor creates some risks that don’t fit the usual intuition for Indexed UL products and, consequently, producers don’t know to talk about them. I go through both of these issues in abundant detail in the full review of PDX, but they’re not worth discussing further here.
The 50% Option Profit Assumption and PDX
Finally, I don’t think this is the right class for applying more risk and leverage. I’ll shortcut a much longer conversation to say that there is mounting evidence (see Ibbotson and Cannex) that a reasonable expectation for long-term equity call profits is more like 10%, not the 50% option profit assumption commonly shown in Indexed UL illustrations. As a result, I don’t think Indexed UL needs more risk or leverage. Indexed insurance products, as Cannex says, are “a decidedly fixed income product with an arms-length relationship to equities.” Developing structures in Indexed UL to increase leverage and risk belies the fundamental point of the product and pushes our story to places we really shouldn’t go. Are we, as an industry, selling life insurance or are we selling leveraged exposure to complex and non-linear derivatives instruments? Increasingly, it looks like the latter – and that’s a huge, existential problem made only worse by the spate of new Indexed UL products that are purposely designed to increase leverage and risk, of which PDX is arguably the first but is certainly not the last.
An Epilogue for the PDX Review
In retrospect, there were a few things that I should have done differently in the full PDX review that are worth discussing here.
First, I didn’t give credit to PacLife for some of the “safety features” of the product, which include a guaranteed death benefit provision, a 2% cumulative guaranteed interest floor that also refunds the fixed charges going to MX and the ability to exchange the policy to any other PacLife contract in the 8th year. These features probably provide some value, but their benefits aren’t enough to materially change the risk profile of the product. PDX is usually funded to the gills, so guaranteeing the death benefit seems superfluous. The 2% cumulative guaranteed interest floor is somewhat of a backstop in early years, but the charges eat it up in the long run. These features are certainly better than nothing, but again, I don’t see them as fundamentally offsetting the risk/return profile of the product.
Second, I didn’t draw a clear enough line to my core problem with PDX – the fact that its competitive edge is reliant on a highly complex and undisclosed bonus mechanism. The lack of disclosure about how the Performance Factor actually works is a deal killer for me, regardless of anything else about the product. I also took issue with the fact that PDX introduces more risk and leverage than typical Indexed UL products, a fact that I think has been poorly understood by agents and distributors because it’s so easy and profitable to not understand it. As I said above, risk and leverage is not inherently a bad thing. They’re only a problem when they’re swept under the rug in favor of showing fantastical illustrations. In my experience in seeing real cases, that unfortunately happens all too often with PDX.
Third, I wasn’t clear enough about the fact that PDX is not a bad product. Selling it will not send you to jail, despite what another industry commentator has said. It is a lot of things, but it is not “bad.” It is poorly disclosed. It is unnecessarily complex. It is often insufficiently or inaccurately explained by the people who sell it. But it most certainly is not a bad product. If you believe what people who sell Indexed UL believe about 50% option profits, then PDX is going to create systematically and structurally superior outcomes for clients. If you don’t, then you think PDX is probably going to be lackluster at best and certainly not worth selling over simpler and more transparent products. That’s the tradeoff we’re talking about. Clients will be disappointed, but not ruined, not by a long shot – except for the ones who borrowed millions of dollars to buy PDX and don’t get a long-term sustainable arbitrage between their loan interest cost and policy performance as was promised to them by unscrupulous premium financing promoters, but that’s a conversation for another day.
Finally, if I could do it all over again, I would have guarded the analysis better. I was absolutely crushed to hear that illicit copies of the PDX review were being distributed to people who aren’t subscribers to this site. Why? Because it insults the 110+ people who have paid their hard-earned money to read what I write. Every morning, I wake up humbled, somewhat terrified and entirely motivated to create amazing content for them. So if you value this type of analysis, do what your competitors have already done – join The Life Product Review. You’ll immediately have access to more than 100 articles and, more importantly, you’ll be supporting the creation of hundreds of new ones.
