The four basic components that determine how the policy will perform are:
1. Earnings Interest Rates, Dividends, etc.
2. Mortality - this is the cost of pure life insurance protection basically, how much the company charges for providing the insurance (i.e. how much they feel there is at risk, how much they can lose).
3. Administrative and overhead expenses.
4. Persistency - how many policies stay in-force?
Interest rates tend to change the most and can have a greater ii on the performance of a policy than the other components listed a However, a small change in mortality rates will have a greater ii on the policy performance; though this does not occur very often.
Permanent Cash Value Life Insurance sales are usually based on illustrations prepared by the company or by the agent using software supplied by the company. The illustration typically highlights projected interest rates and estimates policy values in future years. The illustration is a sales tool, so it naturally accents the positive aspects of the proposed policy. The consumer is naturally led to believe that there is greater assurance that the illustrated values will be achieved, than is likely in the real world. There are so many variables that can adversely affect the long term performance of the policy. Mortality expense, and other charges, future investment experience - all of these are, to some extent, not directly controllable by the insurance company. Results can vary - and they certainly will. So think of the illustration more as a convenient way of showing how the policy works, than as a reasonable estimate of future values.
Understanding how all the components interact is integral to understanding how and why the policy performs as it does. When a policy is issued, the company is at risk for the entire death benefit. That’s because the early premium payments go to cover mortality and other expense charges, leaving little or nothing to apply to the cash value. The accumulation of a cash value reduces the company’s net amount at risk.
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