It is important to know what Current Assumption Whole Life (CAWL) Insurance proposals and ledgers do not reveal. Insurance companies or their agents should tell purchasers of life insurance, either verbally or in writing, the following additional information:
- The investment strategy employed by the life insurance company, (e.g., pure portfolio rate, modified portfolio rate, weighted average portfolio rate, old money or new money) in order to warrant the current interest rate assumption. Although not reflected in the ledger statement of the above table, the current interest rate assumption is 10.25 percent for one year and 9.5 percent thereafter. The guaranteed rate at all times is 5.5 percent.
- In addition to the explanation of the investment strategy employed, purchasers should receive a definitive explanation of mortality charges as to the ratio of current charges to the maximum charges that the insurer can impose.
- Another item of importance is the interest rate on any loan against the cash value. More specifically, the company or agent should disclose how much interest the insurance company charges on the loan and how much interest the insurance company pays on the cash value equal to the amount borrowed. For this ledger statement, the rate charged for the loan is 7.41 percent in advance (most companies charge interest in arrears) and the rate paid on the amount of cash value equal to the loan is 6 percent.
- Another figure that company or agent should make clear is the total accumulation account value, which is the amount of money that is earning interest based on the current interest rate assumption. This amount is not, generally the amount of money that the policyowner would receive on surrender of the policy. It also is not generally the amount of money that the policyowner can borrow against.
- In the above table, note that the total cash value includes the value of the rider plus the guaranteed reserve (cash value) of the policy. This is the amount of money that the policyowner would receive on surrender of the policy and the amount of money that the policyowner can borrow against. For balance sheet purposes, one must use this value, not the total accumulation account value. These respective values become the same in year twenty. They differ before year twenty because this policy is a twenty-year, rear-end loaded contract. Thus, the insurer imposes penalties if the policyowner terminates the policy before twenty years.
- The insurer should give the rate of return expressed in terms of compound interest on the ledger statement or through the life insurance agent. Ideally, the insurer should provide it for each year.
- The rate of return upon death for this policy for sequential years is as follows:
- Once one knows the rate of return upon death, one can then determine what one would have to earn before taxes (it is assumed that the death benefit is considered life insurance proceeds and as such not subject to federal or state income taxes) in other financial services products (e.g., mutual funds, certificates of deposit, real estate, or commodities) to duplicate the tax-exempt rate of return provided by life insurance. One determines the before-tax rate of return by dividing the life insurance rate of return by the marginal tax bracket subtracted from 100 percent—for 15 percent, the factor is 0.85; for 25 percent, 0.75; for 28 percent, 0.72; for 33 percent, 0.67; and for 35 percent, 0.65. The results are shown in the table below.
- The insurer or agent should also provide the rate of return upon surrender. When the rate of return upon surrender is positive, it means that taxes are due. Taxes are due on the difference between the cash surrender value and the premiums paid.
- In this case, generally, the rate of return upon surrender even before taxes never equals the interest assumption of 10.25 percent for one year and 9.5 percent thereafter.
- The ledger statement is the official ledger statement produced by the computer service of the life insurance company. It should be “bug-free.” In addition, the ledger statement should contain the following information: guaranteed interest rate to be paid on the cash value, the current interest rate, mortality charges statement, interest-adjusted index, guaranteed fixed loan rate charged for loans made against the cash value, and interest paid on borrowed money.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM