#154 | PacLife PIA 6 & PDX 2 – Part 1

This post is a prelude to the full review and covers what led up to PDX 2 and PIA 6. If you feel very familiar with PDX and the MX and QX Factors, then feel free to skip to the next part of the review.

At first blush, it might seem odd that PacLife has released a second version of PDX, its best-selling, market-defining Indexed UL product that has successfully fended off a bevy of imitators since its release in early 2017. But the truth is that PacLife has been planning for the second-generation of PDX from the beginning. PDX was, for lack of a better term, something of a hack job. It won where it needed to win – illustrated performance – but had gaping holes in transparency, disclosure and even some of the core product functionality. Despite the immense sales success of the product, PDX needed a long-term fix. And, as it turns out, the fix is actually two products rather than one.

But first, I think a little bit of PacLife product development history is in order. PacLife’s original product, Pacific Indexed Accumulator (PIA), has continued largely unchanged for what is now 6 product generations through to the recently released PIA 6. All PIA products are clean, simple and straightforward. They were, and arguably still are, the gold standard in classic Indexed UL product design. The problem with PIA, however, is that classic Indexed UL products are at a structural disadvantage to modern Indexed UL products that rely on bonuses and multipliers to generate high illustrated performance. Pacific Life began to feel the pressure on PIA as early as 2012, when they released Pacific Indexed Performer LT. The two products were identical save for one seemingly minor detail – the fixed charges. PIA, along with PacLife’s other life insurance products, had a flat base charge over the first 10 years to recapture commission costs, issuance costs and (presumably) profitability. PIPLT, on the other hand, used a front-loaded base charge that started high and declined over the 10 year period while still charging something like 25% more cumulatively and roughly 40% more on an NPV basis (at an 8% discount rate).

What did all of those extra charges pay for? You guessed it – an Index Credit Multiplier. In the case of PIPLT2, it was called the Indexed Account Interest Bonus and it varied by issue age, but generally was in the realm of 10-25% and lasted for 10 years or age 70, whichever is later. The longer the bonus period, the smaller the bonus. This type of bonus is an old actuarial gimmick that, as you’ll see later, PacLife has perfected to practically a form of art. The basic idea is that charging early for a policy bonus to be paid in the distant future allows the life insurer to discount those future payments. The most obvious means of discounting is return on capital, meaning that the life insurer can reinvest those proceeds at its return on capital rather than its return on assets. Doing so provides a natural boost to illustrated performance because the charges will be paid back in the form of a bonus that has grown at the return on capital rather than the return on assets.

The second means of discounting future performance is through lapses, which is a catch-all term for actual lapses, surrenders and withdrawals, anything that reduces the account value eligible to receive the bonus. This is more controversial. All policyholders pay steep charges in the first year to fund the future bonus, but only a small fraction remain long enough to collect it. This creates some very enticing math for life insurers. Let’s say, for example, that a life insurer deducts $100 in the first year to fund a bonus to be paid in the 20th year. Based on a return on capital of 8% (after tax), the bonus would be worth $432. But let’s assume that there were 1,000 policyholders with a total of $100,000 worth of initial charges to fund the bonus totaling $432,000 in the 20th year. At a 5% lapse rate, that would leave only 377 policyholders remaining with each one now receiving a $1,143, a whopping 2.65 times the original projection simply because other policyholders lapsed and received nothing. Actuarially, the bonus payout is identical for the life insurer, but the real difference is on the illustration. Now, the illustration can show a $1,143 bonus for each policyholder despite the fact that the bonus is largely funded on the premise that not all original policyholders will actually receive it. This is a cheap and easy way to boost illustrated performance courtesy of reshuffling the benefits between lapsing and persisting policyholders – which is exactly why life insurers have been doing this for years through fixed interest bonuses on Universal Life and now bonuses and multipliers on Indexed UL products. PIPLT2 was no different and, no surprise, it quickly became PacLife’s flagship Indexed UL.

PacLife took the idea of Index Credit Multipliers (ICM) to a whole new level through PDX’s Performance Factor, an opaque and virtually undisclosed ICM that juiced PDX’s performance to heights unseen and rocketed the product to being the #1 best seller in the industry. The Performance Factor essentially had two forms of ICMs, what I called the QX Factor and the MX Factor in the full PDX review. The QX Factor was a modified version of the simple Indexed Account Interest Bonus in PIPLT2. What was the modification? Simply put, Pacific Life appeared to discount the future bonus by more than just cost of capital and lapses. Instead, the QX Factor in PDX’s Performance Factor appeared to also be discounted by other factors, particularly mortality. Older clients got much larger QX Factor multipliers than younger clients. This is controversial on a whole host of levels but primarily because it smacks of tontines, a long-banned insurance design that pays the forfeited benefits of dead members to the final living members. But the net upshot is that the QX Factor was the primary driver of illustrated performance in PDX for many cells, particularly at older ages.

The MX Factor was the more straightforward part of the Performance Factor and the one that Pacific Life actually did obliquely acknowledge in presentations and pieces subsequent to the launch of the product. The MX Factor is a simple charge-funded Index Credit Multiplier. The design is very familiar now that lots of other companies have released charge-funded ICMs, but the twist with PDX is that it used fixed charges rather than asset-based charges to fund the ICM. This caused no small bit of controversy for two reasons. First, Pacific Life didn’t specify which fixed charges went to fund the ICM and which were being deducted as normal fixed charges, leading to plenty of confusion about how the product worked. This was, of course, a self-inflicted wound. PacLife’s refusal to disclose the mechanics of the Performance Factor meant that it also was somewhat limited in explaining to people that the ridiculously high policy charges in PDX were not going to line the pockets of PacLife executives but instead are being used to fund an Index Credit Multiplier. Second, people also rightly pointed out that fixed charge deductions are riskier than asset-based deductions in that poor performance leads to higher charges as a percentage of account value which further increases leverage and risk. As I wrote about extensively, I don’t think the problems with using fixed charges to fund an ICM are as big as they feel intuitively but, regardless, the superior solution for funding ICMs is asset-based charges.

Thinking about PDX in terms of the QX and MX Factors is essential to understanding what Pacific Life’s strategy for PDX 2 and PIA 6. A lot of people have rightly pointed out that PDX 2 doesn’t materially improve on the original’s performance. So why did PacLife bother to roll out a new version? Because improving performance wasn’t the point. Something else was.