my old mutual life policy illustration - part 1

I will hold on any analysis and let's get down to the key elements of the illustration first.

First, a little bit of myself. I am 33/Male/Non-tobacco/live in CA.

Annual Premium: $30k
Death Benefit Option: Level
Initial Face Amount: $1,025,885
Riders: ABR (I was told this comes as the standard with any policy). It stands for Accelerated Benefit Rider. It gives the policy owner access to up to half of the death benefit if the insured is diagnosed with a terminal illness or condition and is expected to live less than twelve months. (This will be sad.) There is no cost of insurance charge for this rider (I guess this is the reason why it comes with any policy. No cost is good). The death benefit and cost of insurance charges for the policy are reduced if you exercie this rider's benefit. Also, an administrative fee and an interest discount are subtracted from any benefit paid under this rider.
Also it says the stop year is 67.

Looking at the footer area, it looks like the illustration is generated by the old mutual software version 3.722A.

I will start putting the numbers of illustration in part 2. I need to figure out how to put everything in a nice tabular format. :)

Seven-Pay Test

Here is another universal life insurance term: Seven-Pay Test. The seven-pay test actually has nothing to do with your paying seven premiums. This is to ensure your insurance policy complying with the TEFRA and DEFRA limits. It basically limits the amount that you can pay into your policy within the first seven years.

I have no clue how the limits are calculated. But the insurance company is supposed to let you know those numbers. And in both of the illustrations (from Aviva and Old mutual life) I have seen, they all let you put premiums for 5 years and in the explanation it gives a different figure saying something like 7Pay. This is the sever-pay test limit. And th premium you will pay has to be less than that 7pay amount.

Besides seven-pay test, there is actually another test called IRC 7702 life insurance test. IRC stands for Internal Revenue Code. You know where this is from. As far as I understand, IRC 7702 is actually more restrictive than 7pay test.

Your 5 year premium is most likely to comply with 7702 test first, meaning the policy is illustrated to allow you to maximize the premiums under the more restrictive 7702 compliance.
if it is compliant with 7702, it will be with 7pay test.

Again, I don't have much clue how the 7702 limits are calculated. I guess the variables are you face amount, your death benefit option and probably the riders you choose.

Do you understand how the limits for 7pay test and 7702 test are calculated?

Participation Rate

I thought I understand what the participation rate means in an equity-indexed life insurance policy until one day I saw an Aviva's illustration showing one strategy is 130% participating in S&P 500 index. How is that possible?

I revisited the missed fortune book. On page 357 and 358, it talks about the participation rate.
My initial understand of participation rate is that the percentage of your account value participated in the stock market. So I was assuming the maximum value of participation rate has to be 100%.

Now by reading the explanation on the book again. It looks like the math is much more complicated. Let's use the same example in the book and see how a 130% participation rate is possible.

Account Value - $10,000
Cost of buying call options for each $1,000 S&P 500 shares - $50
In order to achieve the 130% participation rate, it needs to purchase $10,000 * 130% = $13,000 S&P shares. This equals ($13,000 / $1000) * $50 = $650.

So we are talking about $650 / $10,000= 6.5% return is used to participate in the S&P 500.
Assuming the guaranteed return is 3%. Aviva has to earn 9.5% in its general account for it to be able to provide this type of participation rate.

Mr Douglas also mentioned on page 357, participation rate and linking method are simply functions of dollars and cents in the overall market for call options, and can hardly be used to differentiate between a good and a bad product.

But if a company only offers 50% participation rate, using the above example,
At 50% participation rate, it will purchase $10,000 * 50% = $5,000 S&P shares. This equals to ($5,000 /$1,000) * $50 = $250
$250 / $10,000= 2.5%

If Aviva is earning 9.5% in its general account, does it mean the interest crediting is this:

• 3% guaranteed return
  
• 2.5% return will be used to participate in S&P 500
  
• the rest of them, 4% is still with the general account.
  

To compare both head to head:

Product	130% Participation Rate	50% Participation Rate
	3% Guaranteed	3% Guaranteed +4% Participated in the general account
	S&P 500 Return on the 6.5%	S&P 500 Return on 2.5%

I have absolutely no idea which will be better. It will all depend on the actual S&P 500 return. But I will generally agree the higher participation rate, the better. This does not seem to be aligned with what Douglas was saying.

My head is spinning. I hope I am not misleading anyone but this is my current understanding now.

Why equity-indexed life insurance?

Honestly I don't know. why not use variable universal life insurance?
Equity-indexed life insurance (EIUL) is still relatively new comparing to universal life (UL) and variable universal life (VUL).

The key characteristics of an EIUL policy is that the interests earned in your life insurance policy is based on a stock market index.
I am a big fan of buying index fund and index ETF in my individual brokerage account. The decision was a little easier when choosing index (sometimes called passively) v.s. actively managed fund (ETF).

But EIUL is different. Most of them have caps. A recent illustration from Aviva was showing a 12% cap. And an illustration from Old Mutual life was showing a 15% cap. (I will talk about those illustrations in detail in later posts). One of the advantages was mentioned in "missed fortune", which the sales agent will most likely to emphasize on is that EIUL has a minimum cap as well. What that means it will give those guarantees even if the index has negative returns during the year.

So at the first glance, you will think EIUL is almost perfect. Although it limits the full potential of the indexing but it gives your guarantees.

Is it perfect? I doubt. I wish I have data to back me up on this (I am hoping I can illustrate using real numbers later on). But I am afraid the cap is the very reason you will not have your cash value accumulated as much as it can. What that means is that you might still be better off using the old "BTID" (buy term and invest the difference) way.
I know I needed more analysis.

What is missed fortune?

The simplified version of missed fortunate's gist is "unfortunately" very easy to get misunderstood. If you put the strategy in one sentence, it will be something like this: "Leverage your home equity by re-financing your mortgage then put the money as premiums to buy an Equity-indexed life insurance." This sounds crazy, isn't it?!
I definitely thought so initially. But the part I thought was crazy is the insurance part not so much about leveraging the equity part.

I bought a whole life insurance from New York Life almost 5 years ago but canceled in 3 months. I was young and got married during that time and I simply can't afford the policy. I know, I was not thinking then. I did research afterwards and discovered a lot of people don't like whole life insurance. So the policy only lasted 3 months and obviously I lost all the money since no surrender value had been accumulated yet.

I am learning the lessons and this time I am starting my research on insurance and trying to study as much as I can.