James Christie | Be Aware or Beware Part II

In my previous article titled “Be Aware of Beware – Part 1” we discussed the importance of truly understanding the underlying defaults setup in a carrier’s illustration system.  We explored the “Minimum Non-MEC” solve and uncovered how at times it may be the best solution, but not all the time.  For Part 2 of this series, we are going to discuss two additional default solves commonly used on IUL cases.  The optimal DB option 2/1 switch and the DB reduction solve in an optimal year. Both are widely used, both are often seen as just an afterthought, and both can have positive and negative effects during the life cycle of an IUL policy.

As with the previous article we will follow a structure of understanding what it is, why we do it, the potential issues, and ultimately what you can do about it moving forward.

Solve for an optimal DB option 2/1:

What it is – The illustration system solves for the optimal year to have the death benefit option switch from increasing (Option 2 or B) to level (Option 1 or A). This typically occurs within the first 15 years of the policy and happens right after the premium payments stop.

Why we do it – Similar to the Minimum Non-MEC DB solve, this is another measure to keep the costs low and “optimize” the cash value growth and income potential.  By choosing an option 2 death benefit to start, this squeezes the initial death benefit down even further while still qualifying as life insurance and not becoming a MEC. Then, in the optimal year, it switches to Option 1.  The reason you don’t let the option 2 run forever is that it has a cost associated with it and eventually the cost outweighs the benefit when looking at it purely for cash value growth and income potential. Targets are also typically higher on Option 2 sales than they are on Option 1.

Potential Issues – Remembering to make the change! As I mentioned above, if you don’t make the change in the optimal year the additional cost of the increasing DB could have a negative impact on the cash value growth and the income goals you set with a client. It is also very important to make sure that it is done in the correct year.  If any changes have been made to the policy since it was placed you could run into potential MEC and funding issues if this change is made too early, so it is important to monitor it moving forward.

What to do about it –

This solve can be a great tool, but like many parts of an IUL sale it needs to be managed post issue.  Here is something to consider:

  • Find a product and company with a great post issue policy management platform.  Will you or the client remember 13 years from now to change the DB option from 2 to 1? Putting a reminder in outlook 13 years from now isn’t a great option either. (I seriously know people who do this.) There are a handful of companies that do this very well such as Paclife, Lincoln, and JH to name a few. These types of systems are extremely valuable and don’t show up on a spreadsheet.  It is important to find the right company not just the right product.
  • You could just use a level DB option. The amount of additional benefit you get from going 2/1 in the optimal year is only matched by the complexity it adds to the post issue process.  Again, if managed the right way it can be a great tool.  If left by itself, it could be an issue for you down the road. 

Solve for a DB reduction in optimal year:

What it is – The carrier illustration software solves for the optimal year to reduce the DB as much as possible while not becoming a MEC.  This is typically selected when also using the DB option 2/1 switch. 

Why we do it – Cost reduction. This is another tool to drive the DB down as much as possible, which reduces drag, and still make sure it qualifies as life insurance with the IRS. This solve is a default for some and an option for others.  It was very popular a few years ago and was showing up on most cases I reviewed, but its popularity seems to have waned in recent years most likely due to the added complexity and low benefit.

Potential Issues – It’s another change that needs to be tracked and enacted and if it isn’t done, there will be an impact to the projected outcomes that your client is judging you by. Also, if this is done in the wrong year it can negatively impact the policy.  Furthermore, any changes to the policy in terms of payments, etc. could mean that the optimal year for this reduction could change and it is important to monitor this to make sure that the reduction doesn’t result in the policy becoming a MEC.

What to do about it –I tend not to include it with illustration that I run for clients because the juice isn’t worth the squeeze for me.  I don’t need to show every single dollar of income possible to get the sale with the way that I sell IUL, so this really isn’t that important to me.  If you are going to use it, make sure you understand the year that it is due to occur and continually monitor the policy to make sure that it is still the correct year moving forward and that you also actually make the DB reduction in the proper year.  As mentioned above, some post issue policy management platforms will track this change and alert you and the client in the year that it is due to be done.

There are some instances where I show this option to a client.  Recently I had a case where the insureds were in their late 50’s and still relatively healthy.  If we were able to get preferred, which we did, we had an alternate set of illustrations that purchased $1.5M instead of the minimum non-MEC solve which was right around $1M in death benefit.  Concept behind this was simple. You are insurable now, let’s get some additional death benefit and lock in your insurability knowing that we can always reduce it in the future if you decide you do not need it and want to focus purely on the cash value growth. This provided us with a significant amount of flexibility as well because these clients wanted to potentially put more money into the policy in the future than what we were illustrating at the point of sale.

Not solving for the minimum non-MEC death benefit gave us some room to put additional dollars into the policy without causing any MEC issues. The option to reduce the DB in the optimal year ended up being a great compliment for how we sold these insurance policies.  It was all in the name of flexibility and the clients loved it.

Many of the default pieces of an IUL illustration have the right intent, the key is to make sure you are using them correctly and to also make sure you do them in the future. The tracking of these changes can be the trickiest part of the equation, but if used correctly and put in place at the proper time they can provide real benefits for a client.  On the flip side, if used to create the best illustration possible to win a spreadsheet war you are just setting yourself up for failure.