How to Read Insurance Illustrations
Thank you for reading my article. Today, I am writing to help you understand more about Insurance illustrations. A life insurance illustration is a document that estimates how a prospective insurance policy will perform over the course of its coverage. Illustrations are used to inform potential policyholders and help agents in their sales process. The illustration will depict expected costs and benefits related to the policy, based on several assumptions about the policyholder and macroeconomic forecasts such as interest rates. Bad assumptions will lead to poor projections, which can significantly alter a policy's actual performance from the initial illustration.
Breaking Down Policy Or Sales Illustration
A policy or sales illustration also shows the insurance product's name, term, benefit amount, premium, cash values (if the policy has a cash value component), and projected dividends (if the policy is being issued by a mutual insurance company). The illustration will also describe any policy riders or options. A policy illustration shows how the policy's value is expected to change over time and what assumptions those values are based on. A disability policy illustration will also show the waiting period before benefits become payable and describe the conditions that must be met for the policy to payout.
A policy or sales illustration is not a binding contract and does not guarantee how much a policy will be worth in any given year, except where values are explicitly stated as "guaranteed." The illustration is largely an educated guess determined by a computer program based on the available information at the time the illustration is generated. The actual legal guarantees associated with the policy are contained in the policy's contract.
To create a life insurance illustration, the agent plugs many different variables into a software program developed by the insurer. Some of these variables will include your age, health rating, and family medical history. Other variables include how you plan to pay, the assumed rate of return, and the age you will be at the end of the policy. These variables help the software calculate the cost of insurance, policy charges, expenses, and riders. Finally, the variables determine a planned or target premium.
How to Read Insurance Illustrations
Check Your Variables on the First Few Pages
The first few pages of the illustration contain an explanation of the coverage, terms, and definitions. Every company’s illustrations differ, as do illustrations for different kinds of coverage.
As you look through these pages, you want to verify that the agent entered your correct variables—check that your rating, age, and how you plan to pay are all correct. Also, check any riders that are part of the policy, the premium, and if the policy has a level or increasing death benefit (sometimes called option 1 or 2). If you have a policy with a level death benefit of $250,000 and a $25,000 cash value, the policy will only pay out $250,000. A policy with an increasing death benefit of $250,000 and a cash value of $25,000 would pay $275,000 (the $250,000 death benefit plus the $25,000 cash value). Since you are buying more insurance with an increasing death benefit, the numbers in the illustration will differ.
Read the Ledger or Table
Next, you want to look for a ledger or table, usually on or near a page that requires your signature. Based on the proposed premium, these ledgers (labeled "guaranteed" and "nonguaranteed") illustrate, in five-year increments, how the policy could perform under different scenarios.
Examine the Rate of Return Assumptions
When reviewing the ledgers, it’s important to think about your risk tolerance and the rate of return assumptions. If an aggressive return is illustrated in the nonguaranteed ledger, for example, variable policies often assume a 7-8% return after fees and expenses, and the actual return is less the policy could lapse prematurely, or you will have to significantly increase your premium payment at some point in the future.
Since you are buying permanent life insurance to cover the rest of your life, it's a good idea to take a conservative approach. Don’t get sold on the best-case scenario of high returns every year and endlessly growing cash values.
Thank you for reading and have a great day!