LIFE INSURANCE PRODUCTS AND SERVICES

Edward E. Graves

Equity-indexed Annuities

What Was the Situation Before?

Annuity contracts were either variable contracts or fixed-dollar contracts relying primarily on bonds and mortgages for investment income. The fixed annuity contracts were very popular during the era of high interest rates (the 1980s and early 1990s). However, as interest rates dropped and stock market returns strengthened, the demand for fixed annuity contracts dropped off. Many purchasers of annuities selected variable annuity contracts, but the insurers were aware that some potential purchasers were reluctant to select variable annuities because they were not willing to assume all the investment risk.

What Is the Nature of the Change?

As a result of the reluctance of some potential purchasers, some insurers have designed new annuity products to enhance the investment return on the fixed annuity contract while maintaining the guaranteed minimum interest rates. These products, called equity-indexed annuities, are fixed, deferred-annuity products. They were introduced in the mid-1990s to enhance the appeal of fixed annuities.

Product Evolution. Some insurance companies have introduced equity-indexed annuities as a product that still offers guaranteed minimum interest rates and at the same time will pay a higher return if the specified stock index increases enough to provide a higher yield. These products are promoted as offering the best of both worlds—fixed-interest debt investments (bonds and mortgages) and equities (stocks). They are designed to appeal to persons who want to participate in high-equity investment yields without bearing the full investment risk that must be assumed in the purchase of a variable annuity. Variable annuities are still the only annuity products that provide most of the full yield of the equity investments to the owner/annuitant.

The equity-indexed annuity provides only a portion of the capital gain of the stocks making up the applicable index (commonly the Standard & Poor’s 500 Composite Stock Price Index). Since the formulas look at the value of the index only at anniversary dates, there is no way to capture the dividend income (if any) of those stocks in the formula approach used in the equity-indexed annuities. It is difficult for prospective purchasers of these annuities to find accurate information about past performance of the capital-gain portion of the index because most sources report the combined total return—both capital gain and income from dividends. Over the past 20 years, about 20 percent of the total return of the Standard & Poor’s 500 Index (S&P 500) has been from the income portion.

Participation Rate Formula. Prospective purchasers of equity-indexed annuities need to understand that their potential return based on increases in the value of the index is determined by the actual formula approach set forth in the contract. Generally this formula includes a participation rate as well as an increase in the index from the beginning of the term to the acceptable anniversary-date value of the index. Some contracts use the increase in the index to the anniversary date during the specified term period (ranging from one year to 8 years, depending on the specific contract) when the index reached its highest value. The participation rate is a percentage (always less than 100 percent) of the defined increase that will be used to calculate the crediting amount. This participation rate is set by the insurer and is subject to change. Some companies do not even specify the current participation rate in their promotional materials. Often the rate is guaranteed for a specified first term, such as 5 or 7 years. The insurance company reserves the right to change the participation rate at the expiration of each term but usually guarantees the then-current rate for the subsequent term.

Most contracts anticipate a series of terms of uniform length, much like renewals of 5-year term life insurance. However, some contracts reserve the insurer’s right to modify the term period available for continuation at the expiration of any existing term. In most designs, the higher increase from the index calculation is available only at the end of the applicable term unless the owner dies or the contract is converted to benefit-payout status (annuitized) before the end of the term. The higher value based on the index will not apply if the contract is terminated before the end of the term.

The participation rate is very important in that it restricts the amount of the index gain (if any) that can be applied to get more than the guaranteed yield. There is also a link between the participation rate and the guaranteed interest rate. Higher participation rates may be available from some insurers if the purchaser will accept a lower guaranteed interest rate. For instance, one company guarantees that the participation rate will never be lower than 25 percent. Illustrations are often based on 80 or 90 percent participation rates. It is reasonable to assume that participation rates range from 25 to 90 percent. Under most contracts, the participation rate cannot be changed more than once a year.

Another aspect of the indexed benefit is that some contracts include a cap on the crediting rate that can be applied to the accumulated value of the contract. This cap may be a single stated percentage applicable to the whole participation period (contract term). It can be stated as an annual equivalent that, in turn, determines the aggregate limit for the full participation period. The existence of such a cap prevents even the full formula participation in times of very rapid index increases.

As a protection on the down side, most contracts specify a floor of zero percent as the minimum interest crediting rate applicable to the accumulated value. This prevents the application of a negative percentage in the formula to reflect plunges in the index value.

The intent is that the fixed-interest-rate guarantee is the worst possible outcome, and if the equity index does better, the accumulation may be even better than the guaranteed accumulation. The marketing material touts this feature as presenting the best of both worlds. Equity-indexed annuities are clearly designed to appeal to purchasers who want higher yields than bonds have provided in the mid-1990s.

No Securities and Exchange Commission Regulation. Equity-indexed annuities satisfy another objective of the insurance companies: they are classified as fixed annuities and can be sold by agents who are not licensed to sell variable products. Thus the agent has a product that is partly influenced by equity performance and that offers a minimum-accumulation guarantee. The agent can sell the product without having to acquire a new license and thus avoids the training requirement and commitment necessary to enter the variable-annuity market.

It is worthy of note that the Securities and Exchange Commission (SEC), which is currently examining insurance products, could decide that equity-indexed annuities really are a variable product rather than a fixed product. Many experts argue that the current definitions of terms adhered to by the SEC are broad enough for such an interpretation without changing any existing authorizations or guidelines. Others believe that equity-indexed annuities cannot be classified as variable products without some action to change the SEC definitions.

In early 1997, one insurance company introduced an equity-indexed annuity contract that it describes as an investment product. The product is registered with the SEC and is sold by registered agents using a prospectus.

The Guarantees. The minimum guarantees under equity-indexed annuities are lower than those for traditional fixed annuities. In fact, the rates that are actually guaranteed apply to less than the full amount paid as a premium. It is common to apply the guaranteed rate to 90 percent of the amount paid to purchase the annuity. That percentage (often 10 percent) not included in the guarantees can be used to cover insurer expenses. With this approach it usually takes 3 or 4 years before the guaranteed amount equals or exceeds the initial purchase amount. The guaranteed rate may result in only a 10 percent gain over a 7-year term when calculated on the full original purchase price. The specified interest rate applied each year to the contract value is set forth in the contract and remains fixed unless a negotiated change is later agreed to by both the contract owner and the insurance company. Many of the existing equity-indexed annuities’ guaranteed rates are in the range of 3 to 3.5 percent.

Value of the Contract at End of Term. At the end of each term, or participation period, the value of the annuity will be the greater of the following three amounts:

• the contract value based on the minimum interest-rate guarantees.
• the accumulated value derived by applying the participation rate to the increase in the index on the applicable anniversary. This amount will be subject to any cap on maximum crediting rate and to any floor on minimum crediting rate.
• the purchase premiums paid up though the end of the term. (Partial withdrawals will be deducted from the premium amount.)

In many contracts the same procedure will be used to calculate the death benefit payable if the owner dies during the deferral phase of the contract.

Terminating an equity-indexed annuity before the end of a specified term will usually result in loss of the index-crediting option. The termination benefit will usually be the greater of the following two amounts:

• the guaranteed-interest contract value
• the aggregate purchase amount less adjustments for any partial withdrawals previously taken

Annuitization. The equity-indexed annuity can be converted to benefit-paying status at any time prior to the maximum age specified for mandatory benefit payout. For qualified annuity contracts, the benefit payout must meet the minimum distribution requirements of the tax law. For nonqualified annuities, the benefit payout does not have to begin before age 85 with some insurers and may be pushed beyond that by an insurer in the future.

Tax law forces payout of qualified annuity contracts starting at whichever of the following times is later:

• April 1st of the year following the year in which the annuitant reaches age 70 l/2
• April 1st of the year following the year the annuitant retires

Most equity-indexed annuities in force were issued before the 1996 tax law change that permits delay of annuitization until retirement if that is later than age 70 l/2. Consequently many equity-indexed annuity contracts used for IRA purposes or other qualified plans will force the start of benefits before retirement for people working beyond age 70 1/2.

The tax law does not mandate a maximum age for distributions to start for nonqualified annuities (those purchased with after-tax dollars). It is the insurer that imposes the maximum age constraints on nonqualified annuities.

The benefits-payout options are the same as those for any other type of fixed annuity contract, as is the taxation of equity-indexed annuities.

Indexes. Although the most commonly used index is The Standard & Poor’s 500 Composite Stock Price Index, some insurers use another index specified in the contract. These are generally established indexes that are regularly published in financial publications such as the Wall Street Journal. However, some insurers have chosen to use international indexes or a composite of two or more established indexes. This puts the definition of the index under the insurance company’s control, and theoretically the company could change the definition of the index after the contract is created, leaving open the possibility of intentional manipulation of the index in the future.

The contracts often set forth an alternative index to be used in case the primary index ceases to exist in the future.

Asset Match. All financial products involve risks, and the equity-indexed annuity is no exception. The issuer needs to invest in assets that will provide an adequate return to honor the contractual promises.

Since the index participation promises some results that are above those of bond returns when the stock index outperforms the bond market, how will a company invest assets to produce the higher increment? The closest match will come by investing some funds in the same stocks that make up the index. However, some insurers have chosen to invest in derivatives and other financial assets that they feel will track well with the index even though these choices are not a composite of the items that make up the index. Over the long run there could be a significant difference between investment results and contractual obligations. If the investment results exceed the contractual obligations, there will be no problem honoring the annuity contract terms. On the other side, though, underperformance of asset returns relative to obligations could threaten the insurer’s financial viability. Purchasers should feel more comfortable with issuing companies whose investments more closely resemble the index the benefits are related to.

The equity-indexed annuity concept is an acceptable composite approach to fixed annuities. It needs much more explanation than the traditional fixed annuity contract. If purchasers do not fully understand the features and the very limited extent to which these annuities participate in the index, they may later be extremely disappointed and revert to class action suits to seek redress. A small number of insurance companies are taking an aggressive stance on both indexes and investments that could potentially tarnish this product, which would be unfortunate because the concept is a sound one and many insurers seem to be taking a responsible approach to both the choice of the index and the offsetting asset portfolio mix.

Equity-indexed annuities have become highly visible in the market since 1996. In fact, new equity-indexed life insurance policies are now available in the marketplace. Time will tell how successfully equity-indexed products satisfy the needs and desires of the purchasing public.

When Does This Change Take Effect?

This product, which was first introduced in 1995 and is quickly gaining market acceptance, is already available from nearly 20 insurance companies. No doubt there will be more insurance companies introducing the product in the future. If it is considered a success within the insurance industry, it may be available from nearly all life insurers within a few years. Some insurers—usually the more cautious ones—are always willing to let other companies try new ideas and work out some of the problems before adopting the product.

What Should Be Done?

Financial services professionals can become aware of this product and how it is being promoted by getting copies of the promotional materials and reading them thoroughly, and by comparing the differences between different insurer contracts.

It is important to learn what you can about the investment strategy being used to enhance the portfolio yield, assess the strategy, and decide whether you think it is viable for any and all market conditions.

If you market the product, take care to explain it thoroughly. Purchasers need to know that they are not getting to participate in dividend income of the index and that the participation rate is less than 100 percent and can change from what is set forth in the contract. Purchasers should also be aware of how low the participation rate is permitted to go according to the contract.

Furthermore, purchasers of equity-indexed annuities should be informed about how the insurer intends to invest funds to enhance yields above those from debt instruments such as bonds and mortgages. Some insurers are investing in derivatives and highly volatile, high-risk assets.

The index used in the formula is very important. It should be readily available from sources outside the insurance company so it is not subject to internal manipulation.

Indexes based on foreign stock exchanges introduce an additional element of risk due to currency fluctuations against the dollar. Purchasers need to be aware of these factors up front in order not to be surprised by them when they manifest themselves in the market.

This product has the potential to create expectations beyond what it may deliver. Unbridled optimism tied to recent high yields in the stock market may create unrealistically high expectations. There could be negative effects in the future if actual results are significantly lower than expectations.

Where Can I Find Out More?

• HS 323 Individual Life Insurance. TheAmerican College.
• National Underwriter, Life/Health, March 3, 1997, p. 1, and March 24, 1997, p. 14.

Criminalization of Donors

What Was the Situation Before?

Prior to 1997, the only deterrent to giving away assets for the purpose of qualifying for medicaid benefits was a delay in the start of benefit payments. In essence, the delay was equal to the period it would take for medicaid benefits to equal the value of the assets given away. The law applied the delay to gifts made within the 36 months prior to applying for medicaid benefits (The look-back window was increased to 60 months if the gifts involved any trust[s].)

Example: If there is a $60,000 gift in a state where the medicaid payment is $3,000 per month, this formula would result in a 20-month delay of benefit eligibility. That is the period of time that the gifted assets would have supported the individual at the medicaid rate. In that particular state a gift in excess of $108,000 would delay benefits for 36 months.

The intention of the government is that people should exhaust their own assets for their own care before they are eligible for medicaid (welfare) benefits. Congress has always intended to discourage any transfers of assets to other individuals or tax entities to preserve those assets and accelerate access to public welfare benefits.

The widespread practice of attorneys advising elderly clients who needed custodial nursing home care to either give away or rearrange their assets so they could qualify for medicaid prompted Congress to strengthen the discouragement.

What Is the Nature of the Change?

Congress strengthened the penalty for giving away assets to qualify for medicaid benefits by making it a criminal offense. The punishment for violation can be up to one year in prison and up to $10,000 in fines to the donor. This change in the law (Sec. 217 of the Health Insurance Portability and Accountability Act, also known as Kennedy-Kassebaum) simply states that any transfers that would trigger a delay in benefits under the prior law are illegal. There was no attempt to modify the prior statute specifying the delay. This is important because the original statute was never intended to impose criminal penalties. There is a lack of detail in the existing law that makes it less than clear what the dividing line is between legal transfers and illegal transfers. The wording is that knowingly and willfully disposing of assets to become eligible for medicaid is illegal.

Legal scholars are divided in their interpretations. Some believe that any transfer that could trigger a delay in benefits is illegal. Others argue that only those transfers that actually result in the imposition of a delay in benefits are illegal. The first interpretation could turn anyone who has given away assets into a criminal if he or she ever subsequently applies for medicaid benefits.

When Does This Change Take Effect?

The new law makes criminal penalties applicable to gifts made after December 31, 1996. Those who interpret the law to apply only to actual delays in benefits suggest that the law is easily circumvented. They advise that no application for benefits be made until 36 months after a transfer (60 months if a trust is involved). Following that same interpretation, they advise postponing the application for benefits to some point after the end of any potential delay if the gift is small enough that the delay would be less than 36 months (60 months for trusts).

The stricter interpretation would make the transfer itself a crime if the donor ever applies for benefits; the time of application for benefits would be irrelevant. This could be a shock to persons who gave away assets before they were forced into early retirement or otherwise lost their income and subsequently became destitute.

There is no question that Congress wants to curb giving that is motivated by a desire to qualify for medicaid benefits. The financial pressure on medicaid is already exhausting both federal and state funds, and the future increases in demand due to an aging population will worsen the situation. It is conceivable that Congress will get even more aggressive and expand the scope of what are classified as illegal transfers.

What Should Be Done?

Anyone considering gifts of assets in order to qualify for medicaid benefits should consult an elder law attorney as to the advisability of such actions. To some extent, the decision will be influenced by the expected interpretation of the less-than-clear law.

Attorneys are less likely to suggest a giving program to qualify for medicaid because there are also criminal penalties applicable to advisers who recommend gifts to accelerate benefit eligibility (up to 5 years’ imprisonment and up to $25,000 in fines).

Those who have enough assets to want to preserve them for other family members may well be advised to purchase long-term care insurance while they are healthy, thus giving them insurance benefits to cover custodial care if it is needed. Such coverage provides many options not available to medicaid beneficiaries.

The benefits are payable even in upscale facilities that are not certified for medicaid benefit eligibility. Many long-term care policies provide benefits for home care and other circumstances outside of a nursing home. The protection of a long-term care policy allows the insured to maintain dignity and avoid the stigma of taking welfare benefits. It also allows the insured to avoid becoming dependent on his or her children to help pay for nursing home care. This protection may also enable persons with long nursing home stays to preserve assets for bequests to family or charities.

Long-term care policies are not appropriate for persons who are already eligible for medicaid or whose assets will quickly be diminished to the level of medicaid eligibility. With the average cost of nursing home care exceeding $36,000 per year ($3,000/month), it does not take long to exhaust most people’s accumulated assets once they enter a nursing home. These people have fewer choices and may have to wait for an opening in a facility after they need care.

Gifts of assets should be made at least 36 months before applying for medicaid benefits.

Where Can I Find Out More?

• HS 323 Individual Life Insurance. The American College.
• Eldercare News.
• "All About Medicaid," National Underwriter.
• "Tax Line," National Underwriter, March 1997, p. 4 (vol. 97, no. 3).

Life Insurance Policy Illustrations

What Was the Situation Before?

Prior to January 1, 1997, there were no standards for life insurance illustrations. Since the 1980s, life insurance sales have frequently been based on computer-generated illustrations. Many of these illustrations were created on personal computers using software that allowed the agent to change some factors, such as interest. In some instances these illustrations were based on unrealistically high interest assumptions.

The purchasers of life insurance relying on these illustrations became very dissatisfied; in fact, in some of the more blatant cases, policyowners have actually sought damages through litigation.

The most problematic illustrations were those depicting the use of policy dividends to pay policy premiums and grossly overestimating dividend levels. These policies were sold as "vanishing premium" products. The purchasers claim they were never told that the policy still had premiums after the target vanish date. They maintain that they did not realize the dividends were the key to paying subsequent premiums and that dividends could decrease.

This situation resulted in many class action suits against insurers and agents after numerous unhappy policyowners found out that they still needed to pay premiums after the expected vanish date.

There has been much criticism of illustrations, resulting in various actions. A study was done by the Society of Actuaries and the Board of Actuarial Standards. The American Society of CLU & ChFC created a Professional Practice Guideline for illustrations and supplanted that with a life insurance illustration questionnaire. This questionnaire is intended to be filled out by the insurer’s home office staff to describe the assumptions used to generate illustrations. The questionnaire was designed for use by agents and other financial services professionals.

The litigation and other activities dealing with illustrations prompted the National Association of Insurance Commissioners (NAIC) to appoint a task force and develop a model regulation.

What Is the Nature of the Change?

With the stated purpose of protecting consumers and fostering consumer education, in 1996 the NAIC adopted a model regulation pertaining to life insurance illustrations. This is the NAIC’s first attempt to set standards for policy illustrations. By January 1, 1997, two states (North Carolina and Utah) had already adopted the model regulation, and additional states are expected to adopt some form of the regulation in 1997. The regulation will probably be effective by January 1, 1998, or later in California, Iowa, Louisiana, North Dakota, New York, and Pennsylvania.

The new model regulation is already having an impact on illustrations in all states because many life insurance companies are moving toward using the same illustration model in every state so they do not need different software systems for each state. Within companies seeking uniformity in all states, all the illustrations are being made to conform to the most stringent state’s requirements.

The new regulation does not apply to variable life, credit life, or life insurance with a face amount of less than $10,000, nor does it apply to either individual or group annuity contracts. The new regulation does apply to all nonvariable group and individual life insurance policies and certificates for more than $10,000 of death benefit.

The regulation requires the insurance company to declare to the state insurance department for each policy form whether or not it intends to use illustrations to market that form of coverage. A copy of each illustration the insurer intends to use must be forwarded to the state insurance department. Each illustration used in the sale of a life insurance policy covered by the new regulation must be clearly labeled "life insurance illustration" and must include the following:

• name, age, and sex of the proposed insured
• the underwriting or rating classification upon which the illustration is based
• the generic name of the policy (for example, whole life, universal life, and so forth)
• the initial death benefit amount
• the dividend option election or application of nonguaranteed elements, if applicable

The NAIC model regulation prohibits insurers and their agents from the following:

• representing the policy as anything other than a life insurance policy
• using or describing nonguaranteed elements in a manner that is misleading or has the capacity or tendency to mislead
• stating or implying that the payment or amount of nonguaranteed elements is guaranteed
• using an illustration that does not comply with the illustration regulation
• using an illustration that is more favorable to the policyowner than the illustration based on the illustrated scale of the insurer
• providing an applicant with an incomplete illustration
• representing in any way that premium payments will not be required for each year of the policy in order to maintain the illustrated death benefits, unless that is the fact
• using the terms "vanish," "vanishing premium," or any similar term that implies that the policy becomes paid up to describe a plan for using nonguaranteed elements to pay a portion of future premiums
• using an illustration that is not "self-supporting"

The NAIC model illustration regulation specifies that all illustrations must be dated as of the date prepared. All pages must be marked to indicate both the individual page number and the total number of pages in the illustration (for example, "page 3 of 7"). The illustration must clearly indicate which elements are guaranteed and which are nonguaranteed. Any amount available upon surrender shall be the amount after deduction of surrender charges. Items presented in illustrations can be in the form of charts, graphs, or tabular values.

Each illustration must be accompanied by a narrative summary that describes the policy, premiums, and features and defines column headings used in the illustration. The summary should also state that actual results may be more or less favorable than those shown in the illustration.

Universal Life Policies

The regulation states that illustrations for universal life policies must comply with the regulation requirements and additionally that the insurance company must issue annual reports to policyowners after the policy is issued. These annual reports must specify the beginning and ending dates for the reporting period.

The content of the annual reports is specified in the NAIC model regulation as follows:

• all transactions affecting the policy during the reporting period (debits and credits) and a description of each (for example, premiums paid, interest credited, loan interest debited, mortality charges, expenses debited, rider transactions, and so forth)
• cash values at the beginning and end of the period
• death benefit at the end of the reporting period (for each life covered)
• the cash surrender value at the end of the period after deduction of surrender charge (if any)
• the amount of outstanding policy loans, if any, at the end of the report period
• a special notice to policyowners if the policy will not maintain insurance in force until the end of the next reporting period unless further premium payments are made

The regulation further stipulates that policyowners have the right to request an in-force illustration annually without charge. The insurer must provide information regarding where and how to direct such requests and must supply a current illustration within 30 days of the request. Such illustrations are to be based on the insurer’s present illustrated scale.

Annual Certifications

Each insurer’s board of directors must appoint at least one illustration actuary, who will certify that the illustrations are in compliance with the illustration regulation and are insurer-authorized. The regulation states the qualifications of an illustration actuary, including membership in good standing of the American Academy of Actuaries.

The illustration actuary must annually certify the method used to allocate overhead and expenses for all illustrations and must file such certification with the insurance commissioner and with the insurer’s board of directors. Further, the illustration actuary is required to report any mistakes found in previous certifications to both the commissioner and the board of directors. Also the insurance commissioner must be notified of any change in the illustration actuary and the reasons for the change.

The model regulation sets forth limits on the methodology for calculating illustrations. These limits are intended to curb some of the overly optimistic projections that a few insurers were utilizing in recent years in the absence of any standards or constraints. Most of the new constraints are contained in the definitions of currently payable scale, disciplined current scale, and illustrated scale.

These definitions are as follows:¹

• currently payable scale: a scale of nonguaranteed elements in effect for a policy form as of the preparation date of the illustration or declared to become effective within the next 95 days
• disciplined current scale: a scale of nonguaranteed elements constituting a limit on illustrations currently being used by an insurer that is reasonably based on actual recent historical experience, as certified annually by an illustration actuary designated by the insurer. Further guidance in determining the disciplined current scale as contained in standards established by the Actuarial Standards Board may be relied upon if the standards

   

  (1) are consistent with all provisions of this regulation,

  (2) limit a disciplined current scale to reflect only actions that have already been taken or events that have already occurred,

  (3) do not permit a disciplined current scale to include any projected trends of improvements in experience or any assumed improvements in experience beyond the illustration date, and

  (4) do not permit assumed expenses to be less than minimum assumed expenses.

• illustrated scale: a scale of nonguaranteed elements currently being illustrated that is not more favorable to the policyowner than the lesser of

   

  (1) the disciplined current scale, or

  (2) the currently payable scale.

1. From section 4, Life Insurance Illustrations Model Regulation.

Outlook

It is important to note that even if all states adopt the model regulation, there will still be wide variation in acceptable underlying assumptions. (Texas has already deviated significantly by adopting an incompatible regulation.) Illustrations will never be an accurate prediction of future results or policy performance. Actual future situations will be heavily influenced by the economy and by the investment performance of the specific insurance company’s actual portfolio.

Illustrations are useful for showing how a policy works and how sensitive a policy is to given changes in factors such as interest, mortality, or expenses. However, illustrations are of limited value for comparing different policies (whether from the same insurer or from different insurers).

The new regulation will no doubt eliminate some of the past abuses in illustrations where the assumptions were based on unfettered pie-in-the-sky optimism. The new restrictions do not constrain illustrations to such an extent that apples are being compared to apples. It is still important to study all the questions about the underlying assumptions. Those questions are set forth in the Life Insurance Illustration Questionnaire (IQ) developed by the American Society of CLU & ChFC and included at the end of this chapter, beginning on page 6.18.

When Does This Change Take Effect?

The NAIC model regulation became effective on January 1, 1997, in at least two states. Each subsequent adoption will have an individual effective date for each specific state. If the model regulation or some variation of it is not adopted within a particular state, there will not be an effective date for that state with respect to constraints and enforcement.

However, large insurers trying to comply with the new regulation everywhere they conduct business have already been taking steps to comply. In many companies the implementation is being phased in as quickly as possible. The actual illustrations from most large insurers doing business in all states are already in compliance. However, the computer systems to support the new illustrations are being massively revised. Short-term steps were taken quickly to comply, but better-integrated incorporation requires longer-term system programming developments. Large home office computing systems are not as flexible as personal computers and require very careful coordination with all the other ongoing computing requirements. These systems are already running around the clock 7 days a week to process a myriad of transactions and generate reports. Compliance with the new illustration regulation shifts to the centralized system a major processing burden that had been performed at the agency or agent level, creating some logistic nightmares for home office systems. They are modifying their programs as rapidly as possible while still providing the daily processing and support for all home office functions. The phase-in should not disrupt the regular processing but has the potential of delaying or disrupting everything on the system. Full integration of centralized illustrations may take a few years as desirable features and enhancements are developed and implemented.

There will be much frustration in the field force as this new approach to illustrations evolves. Their hands have been tied with respect to generating customized illustrations. Agents understandably perceive the change as a reduction in support resources and a development that makes their job much harder.

What Should Be Done?

Financial services professionals should familiarize themselves with both the nature and the spirit of the illustration regulations so they know what is prohibited and what is required. Knowing the new constraints will help practitioners understand insurer reactions and changes in company procedures. It will also make it clearer to know how to always be safely in compliance.

Agents and prospects need to sign the illustrations. Every page of an illustration must be presented to the prospect. Agents need to maintain adequate records to verify that their illustrations are in compliance. It is appropriate to remember that the judicial system still relies heavily on paper documentation as convincing evidence. Preserving a collection of memos will make it possible to convince a court that oral testimony is credible.

Where Can I Find Out More?

• HS 323 Individual Life Insurance. The American College.
• Insurance company materials.
• The Official N.A.I.C. Model Insurance Laws, Regulations and Guidelines. NIARS Corporation, 8120 Penn Avenue South, Minneapolis, MN 55431.
• Life Association News.
• Life Insurance Selling.

Replacement Questionnaire

What Was the Situation Before?

Prior to the 1980s insurance companies universally discouraged replacement of one life insurance policy with another. However, with the premium reductions of the 1980s and the introduction of universal life policies, many insurers eliminated their objections to policy replacements. Now that insurance regulators are focusing on agent conduct, there is renewed interest in discouraging replacements. The American Society of CLU & ChFC was the first independent organization to create any document addressing the issues of replacement. Up until that action the only materials addressing the issue came from insurance companies. There are state statutes and regulations requiring that the policyowner be supplied with adequate information from both the existing insurer and the proposing insurer to make a meaningful comparison. There was no uniform approach to replacement evaluation.

What Is the Nature of the Change?

A task force was convened by the American Society of CLU & ChFC to create a questionnaire to help agents and other financial services professionals evaluate replacement proposals. The task force included actuaries, agents, professional organizations, insurance company representatives, educators, and consultants. Their efforts produced a six-page questionnaire intended to be an educational resource for insurance professionals. It was completed in 1995 and approved by the officers and directors of the American Society of CLU & ChFC.

The questionnaire asks for the reason and justification for the proposed change. It states in bold print twice on the cover that replacement is generally not in the policyholder’s best interest. There are questions to determine whether illustration questionnaires have been obtained for both the existing policy and the proposed policy. The evaluator is asked whether the underlying assumptions are comparable and to describe any significant differences. He or she is further asked how long it will take before the policyowner will be in the same or improved position after the replacement with respect to cash surrender values and death benefits (both on a guaranteed basis and an illustrated basis).

Most of the replacement questionnaire is devoted to identifying the similarities in and differences between the two policies. It provides a systematic format for comparison. These factors include term insurance component, interest rate on cash values, interest rates on loans, death benefits, tax treatment of replacement, grandfathered protections that may be applicable to the existing policy, and insurer financial strength ratings.

The intent of the replacement questionnaire is to discourage replacements unless there is a strong and significant advantage to the policyowner for making the replacement. The questionnaire prompts the agent to document the purported strengths and weaknesses of both policies. Use of the replacement questionnaire will prompt evaluation of all significant factors.

When Does This Change Take Effect?

Replacement questionnaires can be used by both the agent representing the existing coverage and the agent proposing the new policy. It is appropriate whenever a replacement is being proposed because it provides a checklist of important factors to be evaluated and compared before a change in coverage is made. The evaluations may become important evidence if the agent is even asked to defend his or her actions with respect to the attempted replacement.

What Should Be Done?

Insurance professionals should become familiar with the replacement questionnaire (included at the end of this chapter) and use it as a basis for evaluating replacement proposals. A report can be composed based on the responses to the specific questions. This report can be preserved in the client files in case it is ever needed in the future to justify actions taken.

Since it is likely that new versions of the replacement questionnaire will be introduced in the future, updated versions should be obtained when they become available (a revision is expected later in 1997). A record should be kept of which version was used between which dates, and file copies of each version used should be maintained.

Insurance professionals who are not members of the American Society of CLU & ChFC may want to consider joining if they are eligible for membership. The Society generally requires that you have either a CLU or a ChFC designation to join. If you want information on pursuing the designations, contact The American College.

Where Can I Find Out More?

• HS 323 Individual Life Insurance. The American College.
• Contact the American Society of CLU & ChFC directly at 270 S. Bryn Mawr Ave., Bryn Mawr, PA 19010-2195. Phone (610) 526-2500. Contact The American College at the same address or by phone at 610-526-1000.
• Check with your insurance company or state insurance regulator to get information on the statutes and regulations applicable to policy replacements in your state.

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Reprinted with permission of the American Society of CLU & ChFC.

Introduction to the Life Insurance
Illustration Questionnaire (IQ)

Contact Person: __________________________________ Date Completed:

Policy(ies) Covered:

Are there any more IQs that cover other policies of this Company?

No Yes	_______
	(how many)

Do the illustration(s) covered by this IQ response comply with the NAIC Life Insurance Illustrations Model Regulation?

No Yes

In the following responses, "scale" means the scale of dividends or other non-guaranteed elements used in the illustration.

Revised 4/96

I. General

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II. Mortality

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1. The interest rate used in the dividend scale or credited in the illustration is (does):

a)

a Portfolio rate (Describe)

an Investment Generation ("New Money") rate (Describe)

Other (Describe)

 

b)

a Gross rate

a Net rate, which is net of

investment expenses income taxes profit or expense charges other ______________

 

c) Include

Realized

Unrealized

No Capital Gains.

If capital gains are included, describe the general method (e.g., smoothed over ___ years).

 

2. Do the interest rate(s) reflect the earnings on all invested assets? A portion of the assets? New investments over certain number of years? (If so, specify number of years.) An index? (If so, briefly describe.)

 

3. At any policy duration, do the company investment earnings rates required to support the scale used in the illustration exceed the company’s actual recent historical earnings rate on the investment segment backing that block of policies?

 

4. Does the interest rate used in the underlying scale reflected in the illustration vary between new and existing policies? Describe.

 

5. Except for any impact of using an investment generation approach, do the interest rates used in the scale reflected in the illustration vary by policy duration? Describe.

 

6. Do the illustrated interest rates vary by product, class or otherwise? Describe.

 

 

7. How does individual policy loan activity affect the illustrated interest rates? Describe.

 

Revised 4/96

 

Reprinted with permission. Copyright © 1997 by the American Society of CLU & ChFC. All rights reserved.

Replacement Questionnaire (RQ)

A Policy Replacement Evaluation Form

Copyright © 1997
American Society of CLU & ChFC
All rights reserved

Replacement Questionnaire (RQ)

A Policy Replacement Evaluation Form

A. 1. What does the policyholder want to achieve that the existing policy cannot provide?

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2. Has the current carrier been contacted to see if the policy can be modified to meet the policyholder’s objectives?

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B. 1. Recognizing that the replacement of an existing policy generally results in the reduction of cash surrender value as a result of new acquisition costs, what is the cash surrender value of:

a. The original policy immediately before replacement________________
b. The original policy immediately after the replacement________________
c. The proposed policy immediately after the replacement________________

These cash surrender values should be obtained directly from the insurance carrier’s policyowner service department and not from an illustration, since illustrations typically reflect end of year values.

2. Illustrations should never be the sole criteria for evaluating a replacement. Additionally, Illustrated Cash Values and Illustrated Death Benefits are never reliable predictions of future results. If these non-guaranteed values and benefits are the basis for considering a replacement, the agent should attempt to know and understand the underlying assumptions in both the inforce illustration for the current policy, as well as the sales illustration for the proposed policy. In addition to reviewing illustrations, the agent should attempt to obtain an Illustration Questionnaire (IQ), which may be available directly from the companies or may be requested through the client. The agent and the client should be aware that there may be differences in the assumptions used by each company which may render a comparison based upon such illustrations invalid.

How many years from now before the proposed policy’s cash surrender values and death benefits exceed those benefits in the current policy?

a. Guaranteed Cash Surrender Values_______years an subsequent.

b. Guaranteed Death Benefits______years and subsequent.

c. Illustrated Cash Surrender Values______years and subsequent.

d. Illustrated Death Benefits______years an subsequent.

 

3. If the proposed policy is a variable life policy, what gross yield rate is being assumed?____%

What is your justification for that rate?

C. 1. Describe the differences in the plans of insurance.________________________________

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2. Describe any term riders or term elements (above the base policy). Include the ratio of the initial term amount to the total death benefit and any term rate guarantees which may or may not be included.

Current policy:________________

Proposed policy:________________

3. Other than term riders, what riders do the policies include?

Current policy:________________

Proposed policy:________________

4. How long is the initial death benefit guaranteed to be in force at the illustrated premium?

Current policy:______years. Proposed policy:_____years.

5. What premium is necessary to guarantee coverage at initial/current levels for life?

Current policy: $________ . Proposed policy: $_______ .

D. 1. Is there a potential taxable gain if the current policy is replaced?

YES NO If yes, how is it to be managed? 

2. If there is a taxable gain, and if there is a loan, how is the loan to be managed?

The new policy will assume the existing loan.
The loan will be repaid.
The policyowner will recognize taxable income.

E. Is an IRC Sec. 1035 exchange planned to preserve basis? YES NO

F. If a replacement is under consideration because a more favorable rate classification is available, has a reduction or removal of the rating on the existing policy been requested? If so, what was the result. If not, explain why such a request has not been made.

G. Does the proposed policy qualify as life insurance under IRC Section 7702?

H. What is the issue date of the current policy?___________________________

The following "grandfathered" features will be lost if the policy is replaced.

(See appendix for explanation of items 3–9.)

1. The current policy is incontestable by the insurance company. YES NO

2. The period has expired during which the insurance company can deny policy benefits in the event of the insured’s suicide. YES NO

The current life insurance policy was issued on or before:			The current annuity policy was issued before:			The current second to die policy was issued before:
	YES	NO		YES	NO		YES	NO
3. 8/06/63			6. 10/21/79			9. 9/14/89
4. 6/20/86			7. 8/14/82
5. 6/20/88			8. 2/28/86

I. If the current policy is term, is a conversion to permanent insurance available? YES NO

 

If so, other than the suicide and incontestable provisions would a conversion to permanent insurance be more advantageous?

YES NO Explanation:______________________________________________________

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J. Financial Strength Ratings. Much has been made of ratings in the last few years; financial strength is important, but it is not the sole determining factor in selecting a life insurance company. A drop in ratings alone generally is not a sufficient reason to replace a policy. It is also important to know that there can be differences of opinion among rating agencies and the small differences in ratings generally are not significant. Furthermore, financial strength ratings are not necessarily indicative of policy performance. If reviewed with the client, a detailed explanation of the ratings must be provided in accordance with state regulations.

K. Policy loans:	Current Policy	Proposed Policy
1. Gross rate	___________________________	___________________________
2. Fixed or Variable?	___________________________	___________________________
3. Permanent policies:      Direct Recognition?	___________________________	___________________________
4. Universal life,etc.      a. Current spread?      b. Is spread guatanteed?	___________________________ YES NO	___________________________ YES NO
L. Additional remarks:

Appendix

Grandfathered Features Explanation

(See question H.)

3. The current policy was purchased on or before 8/6/63, so IRC Section 264(a)(3) which limits deductions for interest indebtedness does not apply. If the current policy has met the "four out of seven" test of IRC Section 264(c)(1), interest on indebtedness is deductible to the extent otherwise allowed by law. Personal interest deductions are generally denied for tax years beginning after 1990, irrespective of when the policy was purchased, IRC Sec. 163(h)(1).

4. The current policy was purchased on or before June 20, 1986. Certain policies purchased for business purposes after this date have a $50,000 ceiling on the aggregate amount of indebtedness for which an interest deduction is allowed. IRC Sec. 264(a)(4).

5. Policy was issued on or before 6/20/88 and is not subject to Modified Endowment Contract rules. IRC Sec. 7702A. Substantial increases in the death benefits of grandfathered contracts after 10/10/88 may cause the imposition of the MEC rules. H.R. Conf. Rep. No. 1104, 100th Cong., 2d Sess. (TAMRA ‘88) reprinted in 1988-3 CB 595–596.

6. Variable annuity contracts purchased before 10/21/79 are eligible for a step-up in basis if the owner dies before the annuity starting date. IRC Sec. 72; Rev. Rul. 79-335, 1979-2 CB 292.

7. An annuity issued prior to 8/14/82 is subject to more favorable (basis out first) cost recovery rules for withdrawals. IRC Sec. 72(e). Such policies are not subject to the 10% penalty on withdrawals made prior to age 59 ½. IRC Sec. 72(q)(2).

8. To the extent contributions are made after 2/28/86 to a deferred annuity held by a non-natural person (such as a business entity), the contract will not be entitled to tax treatment as an annuity. IRC Sec. 72(u).

9. A survivorship life policy issued prior to 9/14/89 is not subject to the 7-pay MEC test if there is a reduction in benefits. IRC Sec. 7702A(c)(6).

Model Regulation Service - January 1996

Reprinted from Model Laws, Regulations and Guidelines with permission from the Association of Insurance Commissioners. Copyright © January 1996

Section 1. Purpose

Section 2. Authority

Section 3. Applicability and Scope

Section 4. Definitions

Section 5. Policies to Be Illustrated

Section 6. General Rules and Prohibitions

Section 7. Standards for Basic Illustrations

Section 8. Standards for Supplemental Illustrations

Section 9. Delivery of Illustrations and Record Retention

Section 10. Annual Report; Notice to Policy Owners

Section 11. Annual Certifications

Section 12. Penalties

Section 13. Separability

Section 14. Effective Date

The purpose of this regulation is to provide rules for life insurance policy illustrations that will protect consumers and foster consumer education. The regulation provides illustration formats, prescribes standards to be followed when illustrations are used, an specifics the disclosures that are required in connection with illustrations. The goals of this regulation are to ensure that illustrations do not mislead purchasers of life insurance and to make illustrations more understandable. Insurers will, as far as possible, eliminate the use of footnotes and caveats and define terms used in the illustration in language that would be understood by a typical person within the segment of the public to which the illustration is directed.

This regulation is issued based upon the authority granted the commissioner under Section [cite any enabling legislation and state law corresponding to Section 4 of the NAIC Unfair Trade Practices Act].

Drafting Note: Insert the title of the chief insurance regulatory official whenever the term "commissioner" appears.

Section 3. Applicability and Scope

This regulation applies to all group and individual life insurance policies and certificates except:

A. Variable life insurance;

B. Individual and group annuity contracts;

C. Credit life insurance; or

D. Life insurance policies with no illustrated death benefits on any individual exceeding $10,000.

Section 4. Definitions

For the purposes of this regulation:

A. "Actuarial Standards Board" means the board established by the American Academy of Actuaries to develop and promulgate standards of actuarial practice

B. "Contract premium" means the gross premium that is required to be paid under a fixed premium policy, including the premium for a rider for which benefits are shown in the illustration.

C. "Currently payable scale" means a scale of non-guaranteed elements in effect for a policy form as of the preparation date of the illustration or declared to become effective within the next ninety-five (95) days.

D. "Disciplined current scale" means a scale of non-guaranteed elements constituting a limit on illustrations currently being illustrated by an insurer that is reasonably based on actual recent historical experience, as certified annually by an illustration actuary designated by the insurer. Further guidance in determining the disciplined current scale as contained in standards established by the Actuarial Standards Board may be relied upon if the standards:

(1) Are consistent with all provisions of this regulation;

(2) Limit a disciplined current scale to reflect only actions that have already been taken or events that have already occurred;

(3) Do not permit a disciplined current scale to include any projected trends of improvements in experience or any assumed improvements in experience beyond the illustration date; and

(4) Do not permit assumed expenses to be less than minimum assumed expenses.

E. "Generic name" means a short title descriptive of the policy being illustrated such as "whole life," "term life" or "flexible premium adjustable life."

F. "Guaranteed elements" and "non-guaranteed elements"

(1) "Guaranteed elements" means the premiums, benefits, values, credits or charges under a policy of life insurance that are guaranteed and determined at issue.

(2) "Non-guaranteed elements" means the premiums, benefits, values, credits or charges under a policy of life insurance that are not guaranteed or not determined at issue.

G. "Illustrated scale" means a scale of non-guaranteed elements currently being illustrated that is not more favorable to the policy owner that the lesser of:

(1) the disciplined current scale; or

(2) The currently payable scale.

H. "Illustration" means a presentation or depiction that includes non-guaranteed elements of a policy of life insurance over a period of years and that is one of the three (3) types defined below:

(1) "Basic illustration" means a ledger or proposal used in the sale of a life insurance policy that shows both guaranteed and non-guaranteed elements.

(2) "Supplemental illustration" means an illustration furnished in addition to a basic illustration that meets the applicable requirements of this regulation, and that may be presented in a format differing from the basic illustration, but may only depict a scale of non-guaranteed elements that is not permitted in a basic illustration.

(3) "In force illustration" means an illustration furnished at any time after the policy that it depicts has been in force for one year or more.

I. "Illustration actuary" means an actuary meeting the requirements of Section 11 who certifies to illustrations based on the standard of practice promulgated by the Actuarial Standards Board.

J. "Lapse-supported illustration" means an illustration of a policy form failing the test of self-supporting as defined in this regulation, under a modified persistency rate assumption using persistency rates underlying the disciplined current scale for the first five (5) years and 100 percent policy persistency thereafter.

K. (1) "Minimum assumed expenses" means the minimum expenses that may be used in the calculation of the disciplined current scale for a policy form. The insurer may choose to designate each year the method of determining assumed expenses for all policy forms from the following:

(a) Fully allocated expenses;

(b) Marginal expenses; and

(c) A generally recognized expense table based on fully allocated expenses representing a significant portion of insurance companies and approved by the [National Association of Insurance Commissioners or by the commissioner].

(2) Marginal expenses may be used only if greater than a generally recognized expense table. If no generally recognized expense table is approved, fully allocated expenses must be used.

L. "Non-term group life" means a group policy or individual policies of life insurance issued to members of an employer group or other permitted group where:

(1) Every plan of coverage was selected by the employer or other group representative;

(2) Some portion of the premium is paid by the group or through payroll deduction; and

(3) Group underwriting or simplified underwriting is used.

M. "Policy owner" means the owner named in the policy or the certificate holder in the case of a group policy.

N. "Premium outlay" means the amount of premium assumed to be paid by the policy owner or other premium payer out-of-pocket.

O. "Self-supporting illustration" means an illustration of a policy form for which it can be demonstrated that, when using experience assumptions underlying the disciplined current scale, for all illustrated points in time on or after the fifteenth policy anniversary or the twentieth policy anniversary for second-or-later-to-die policies (or upon policy expiration if sooner), the accumulated value of all policy cash flows equals or exceeds the total policy owner value available. For this purpose, policy owner value will include cash surrender values and any other illustrated benefit amounts available at the policy owner’s election.

Section 5. Policies to Be Illustrated

A. Each insurer marketing policies to which this regulation is applicable shall notify the commissioner whether a policy form is to be marketed with or without an illustration. For all policy forms being actively marketed on the effective date of this regulation, the insurer shall identify in writing those forms and whether or not an illustration will be used with them. For policy forms filed after the effective date of this regulation, the identification shall be made at the time of filing. Any previous identification may be changed by notice to the commissioner.

B. If the insurer identifies a policy form as one to be marketed without an illustration, any use of an illustration for any policy using that form prior to the first policy anniversary is prohibited.

Drafting Note: The prohibition in Section 5B may need to be modified if required by the state’s replacement regulation.

C. If a policy form is identified by the insurer as one to be marketed with an illustration, a basic illustration prepared and delivered in accordance with this regulation is required, except that a basic illustration need not be provided to individual members of a group or to individuals insured under multiple lives coverage issued to a single applicant unless the coverage is marketed to these individuals. The illustration furnished an applicant for a group life insurance policy or policies issued to a single applicant on multiple lives may be either an individual or composite illustration representative of the coverage on the lives of members of the group or the multiple lives covered.

D. Potential enrollees of non-term group life subject to this regulation shall be furnished a quotation with the enrollment materials. The quotation shall show potential policy values for sample ages and policy years on a guaranteed and non-guaranteed basis appropriate to the group and the coverage. This quotation shall not be considered an illustration for purposes of this regulation, but all information provided shall be consistent with the illustrated scale. A basic illustration shall be provided at delivery of the certificate to enrollees for non-term group life who enroll for more than the minimum premium necessary to provide pure death benefit protection. In addition, the insurer shall make a basic illustration available to any non-term group life enrollee who requests it.

Section 6. General Rules and Prohibitions

A. An illustration used in the sale of a life insurance policy shall satisfy the applicable requirements of this regulation, be clearly labeled "life insurance illustration" and contain the following basic information:

(1) Name of insurer;

(2) Name and business address of producer or insurer’s authorized representative, if any;

(3) Name, age and sex of proposed insured, except where a composite illustration is permitted under this regulation;

(4) Underwriting or rating classification upon which the illustration is based;

(5) Generic name of policy, the company product name, if different, and form number;

(6) Initial death benefit; and

(7) Dividend option election or application of non-guaranteed elements, if applicable.

B. When using an illustration in the sale of a life insurance policy, an insurer or its producers or other authorized representatives shall not:

(1) Represent the policy as anything other than a life insurance policy;

(2) Use or describe non-guaranteed elements in a manner that is misleading or has the capacity or tendency to mislead;

(3) State or imply that the payment or amount of non-guaranteed elements is guaranteed;

(4) Use an illustration that does not comply with the requirements of this regulation;

(5) Use an illustration that at any policy duration depicts policy performance more favorable to the policy owner than that produced by the illustrated scale of the insurer whose policy is being illustrated;

(6) Provide an applicant with an incomplete illustration;

(7) Represent in any way that premium payments will not be required for each year of the policy in order to maintain the illustrated death benefits, unless that is the fact;

(8) Use the term "vanish" or "vanishing premium," or a similar term that implies the policy becomes paid up, to describe a plan for using non-guaranteed elements to pay a portion of future premiums;

(9) Except for policies that can never develop nonforfeiture values, use an illustration that is "lapse-supported"; or

(10) Use an illustration that is not "self-supporting."

C. If an interest rate used to determine the illustrated non-guaranteed elements is shown, it shall not be greater than the earned interest rate underlying the disciplined current scale.

Drafting Note: States may wish to replace discourse requirements under the state’s version of the Universal Life Insurance Model Regulation with the basic illustration as contained in this regulation.

A. Format. A basic illustration shall conform with the following requirements:

(1) The illustration shall be labeled with the date on which it was prepared.

(2) Each page, including any explanatory notes or pages, shall be numbered and show its relationship to the total number of pages in the illustration (e.g., the fourth page of a seven-page illustration shall be labeled "page 4 of 7 pages").

(3) The assumed dates of payment receipt and benefit pay-out within a policy year shall be clearly identified.

(4) If the age of the proposed insured is shown as a component of the tabular detail, it shall be issue age plus the numbers of years the policy is assumed to have been in force.

(5) The assumed payments on which the illustrated benefits and values are based shall be identified as premium outlay or contract premium, as applicable. For policies that do not require a specific contract premium, the illustrated payments shall be identified as premium outlay.

(6) Guaranteed death benefits and values available upon surrender, if any, for the illustrated premium outlay or contract premium shall be shown and clearly labeled guaranteed.

(7) If the illustration shows any non-guaranteed elements, they cannot be based on a scale more favorable to the policy owner than the insurer’s illustrated scale at any duration. These elements shall be clearly labeled non-guaranteed.

(8) The guaranteed elements, if any, shall be shown before corresponding non-guaranteed elements and shall be specifically referred to on any page of an illustration that shows or describes only the non-guaranteed elements (e.g., "see page one for guaranteed elements").

(9) The account or accumulation value of a policy, if shown, shall be identified by the name this value is given in the policy being illustrated and shown in close proximity to the corresponding value available upon surrender.

(10) The value available upon surrender shall be identified by the name this value is given in the policy being illustrated and shall be the amount available to the policy owner in a lump sum after deduction of surrender charges, policy loans and policy loan interest, as applicable.

(11) Illustrations may show policy benefits and values in graphic or chart form in addition to the tabular form.

(12) Any illustration of non-guaranteed elements shall be accompanied by a statement indicating that:

(a) The benefits and values are not guaranteed;

(b) The assumptions on which they are based are subject to change by the insurer; and

(c) Actual results may be more or less favorable.

(13) If the illustration shows that the premium payer may have the option to allow policy charges to be paid using non-guaranteed values, the illustration must clearly disclose that a charge continues to be required and that, depending on actual results, the premium payer may need to continue or resume premium outlays. Similar disclosure shall be made for premium outlay of lesser amounts or shorter durations than the contract premium. If a contract premium is due, the premium outlay display shall not be left blank or show zero unless accompanied by an asterisk or similar mark to draw attention to the fact that the policy is not paid up.

(14) If the applicant plans to use dividends or policy values, guaranteed or non-guaranteed, to pay all or a portion of the contract premium or policy charges, or for any other purpose, the illustration may reflect those plans and the impact on future policy benefits and values.

B. Narrative Summary. A basic illustration shall include the following:

(1) A brief description of the policy being illustrated, including a statement that it is a life insurance policy;

(2) A brief description of the premium outlay or contract premium, as applicable, for the policy. For a policy that does not require payment of a specific contract premium, the illustration shall show the premium outlay that must be paid to guarantee coverage for the term of the contract, subject to maximum premiums allowable to qualify as a life insurance policy under the applicable provisions of the Internal Revenue Code;

(3) A brief description of any policy features, riders or options, guaranteed or non-guaranteed, shown in the basic illustration and the impact they may have on the benefits and values of the policy;

(4) Identification and a brief definition of column headings and key terms used in the illustration; and

(5) A statement containing in substance the following: "This illustration assumes that the currently illustrated nonguaranteed elements will continue unchanged for all years shown. This is not likely to occur, and actual results may be more or less favorable than those shown."

C. Numeric Summary.

(1) Following the narrative summary, a basic illustration shall include a numeric summary of the death benefits and values and the premium outlay and contract premium, as applicable. For a policy that provides for a contract premium, the guaranteed death benefits and values shall be based on the contract premium. This summary shall be shown for at least policy years five (5), ten (10) and twenty (20) and at age 70, if applicable, on the three bases shown below. For multiple life policies the summary shall show policy years five (5), ten (10), twenty (20) and thirty (30).

(a) Policy guarantees;

(b) Insurer’s illustrated scale;

(c) Insurer’s illustrated scale used but with the non-guaranteed elements reduced as follows:

(i) Dividends at fifty percent (50%) of the dividends contained in the illustrated scale used;

(ii) Non-guaranteed credited interest at rates that are the average of the guaranteed rates and the rates contained in the illustrated scale used; and

(iii) All non-guaranteed charges, including but not limited to, term insurance charges, mortality and expense charges, at rates that are the average of the guaranteed rates and the rates contained in the illustrated scale used.

(2) In addition, if coverage would cease prior to policy maturity or age 100, the year in which coverage ceases shall be identified for each of the three (3) bases.

D. Statements. Statements substantially similar to the following shall be included on the same page as the numeric summary and signed by the applicant, or the policy owner in the case of an illustration provided at time of delivery, as required in this regulation.

(1) A statement to be signed and dated by the applicant or policy owner reading as follows: "I have received a copy of this illustration and understand that any non-guaranteed elements illustrated are subject to change and could be either higher or lower. The agent has told me they are not guaranteed."

(2) A statement to be signed and dated by the insurance producer or other authorized representative of the insurer reading as follows: "I certify that this illustration has been presented to the applicant and that I have explained that any non-guaranteed elements illustrated are subject to change. I have made no statements that are inconsistent with the illustration."

E. Tabular Detail.

(1) A basic illustration shall include the following for at least each policy year from one (1) to ten (10) and for every fifth policy year thereafter ending at age 100, policy maturity or final expiration; and except for term insurance beyond the 20th year, for any year in which the premium outlay and contract premium, if applicable, is to change:

(a) The premium outlay and mode the applicant plans to pay and the contract premium, as applicable;

(b) The corresponding guaranteed death benefit, as provided in the policy; and

(c) The corresponding guaranteed value available upon surrender, as provided in the policy.

(2) For a policy that provides for a contract premium, the guaranteed death benefit and value available upon surrender shall correspond to the contract premium.

(3) Non-guaranteed elements may be shown if described in the contract. In the case of an illustration for a policy on which the insurer intends to credit terminal dividends, they may be shown if the insurer’s current practice is to pay terminal dividends. If any non-guaranteed elements are shown they must be shown at the same durations as the corresponding guaranteed elements, if any. If no guaranteed benefit or value is available at any duration for which a non-guaranteed benefit or value is shown, a zero shall be displayed in the guaranteed column.

A. A supplemental illustration may be provided so long as:

(1) It is appended to, accompanied by or preceded by a basic illustration that complies with this regulation;

(2) The non-guaranteed elements shown are not more favorable to the policy owner than the corresponding elements based on the scale used in the basic illustration;

(3) It contains the same statement required of a basic illustration that non-guaranteed elements are not guaranteed; and

(4) For a policy that has a contract premium, the contract premium underlying the supplemental illustration is equal to the contract premium shown in the basic illustration. For policies that do not require a contract premium, the premium outlay underlying the supplemental illustration shall be equal to the premium outlay shown in the basic illustration.

B. The supplemental illustration shall include a notice referring to the basic illustration for guaranteed elements and other important information.

A. (1) If a basic illustration is used by an insurance producer or other authorized representative of the insurer in the sale of a life insurance policy and the policy is applied for as illustrated, a copy of that illustration, signed in accordance with this regulation, shall be submitted to the insurer at the time of policy application. A copy also shall be provided to the applicant.

(2) If the policy is issued other than as applied for, a revised basic illustration conforming to the policy as issued shall be sent with the policy. The revised illustration shall conform to the requirements of this regulation, shall be labeled "Revised Illustration" and shall be signed and dated by the applicant or policy owner and producer or other authorized representative of the insurer no later than the time the policy is delivered. A copy shall be provided to the insurer and the policy owner.

B. (1) If no illustration is used by an insurance producer or other authorized representative in the sale of a life insurance policy or if the policy is applied for other than as illustrated, the producer or representative shall certify to that effect in writing on a form provided by the insurer. On the same form the applicant shall acknowledge that no illustration conforming to the policy applied for was provided and shall further acknowledge an understanding that an illustration conforming to the policy as issued will be provided no later than at the time of policy delivery. This form shall be submitted to the insurer at the time of policy application.

(2) If the policy is issued, a basic illustration conforming to the policy as issued shall be sent with the policy and signed no later than the time the policy is delivered. A copy shall be provided to the insurer and the policy owner.

C. If the basic illustration or revised illustration is sent to the applicant or policy owner by mail from the insurer, it shall include instructions for the applicant or policy owner to sign the duplicate copy of the numeric summary page of the illustration for the policy issued and return the signed copy to the insurer. The insurer’s obligation under this subsection shall be satisfied if it can demonstrate that it has made a diligent effort to secure a signed copy of the numeric summary page. The requirement to make a diligent effort shall be deemed satisfied if the insurer includes in the mailing a self-addressed postage prepaid envelope with instructions for the return of the signed numeric summary page.

D. A copy of the basic illustration and a revised basic illustration, if any, signed as applicable, along with any certification that either no illustration was used or that the policy was applied for other than as illustrated, shall be retained by the insurer until three (3) years after the policy is no longer in force. A copy need not be retained if no policy is issued.

A. In the case of a policy designated as one for which illustrations will be used, the insurer shall provide each policy owner with an annual report on the status of the policy that shall contain at least the following information:

(1) For universal life policies, the report shall include the following:

(a) The beginning and end date of the current report period;

(b) The policy value at the end of the previous report period and at the end of the current report period;

(c) The total amounts that have been credited or debited to the policy value during the current report period, identifying each by type (e.g., interest, mortality, expense and riders);

(d) The current death benefit at the end of the current report period on each life covered by the policy;

(e) The net cash surrender value of the policy as of the end of the current report period;

(f) The amount of outstanding loans, if any, as of the end of the current report period; and

(g) For fixed premium policies:

If, assuming guaranteed interest, mortality and expense loans and continued scheduled premium payments, the policy’s net cash surrender value is such that it would not maintain insurance in force until the end of the next reporting period, a notice to this effect shall be included in the report; or

(h) For flexible premium policies:

If, assuming guaranteed interest, mortality and expense loads, the policy’s net cash surrender value will not maintain insurance in force until the end of the next reporting period unless further premium payments are made, a notice to this effect shall be included in the report.

Drafting Note: For states that have adopted the NAIC Universal Life Model Regulation, this paragraph could be replaced with a reference to the equivalent of Section 9 of the model regulation.

(2) For all other policies, where applicable:

(a) Current death benefit:

(b) Annual contract premium;

(c) Current cash surrender value;

(d) Current dividend;

(e) Application of current dividend; and

(f) Amount of outstanding loan.

(3) Insurers writing life insurance policies that do not build nonforfeiture values shall only be required to provide an annual report with respect to these policies for those years when a change has been made to nonguaranteed policy elements by the insurer."

B. If the annual report does not include an in force illustration, it shall contain the following notice displayed prominently: "IMPORTANT POLICY OWNER NOTICE: You should consider requesting more detailed information about your policy to understand how it may perform in the future. You should not consider replacement of your policy or make changes in your coverage without requesting a current illustration. You may annually request, without charge, such an illustration by calling [insurer’s phone number], writing to [insurer’s name] at [insurer’s address] or contacting your agent. If you do not receive a current illustration of your policy within 30 days from your request, you should contact your state insurance department." The insurer may vary the sequential order of the methods for obtaining an in force illustration.

C. Upon the request of the policy owner, the insurer shall furnish an in force illustration of current and future benefits and values based on the insurer’s present illustrated scale. This illustration shall comply with the requirements of Section 6A, 6B, 7A and 7E. No signature or other acknowledgment of receipt of this illustration shall be required.

D. If an adverse change in non-guaranteed elements that could affect the policy has been made by the insurer since the last annual report, the annual report shall contain a notice of the fact and the nature of the change prominently displayed.

A. The board of directors of each insurer shall appoint one or more illustration actuaries.

B. The illustration actuary shall certify that the disciplined current scale used in illustrations is in conformity with the Actuarial Standard of Practice for Compliance with the NAIC Model Regulation on Life Insurance Illustrations promulgated by the Actuarial Standards Board, and that the illustrated scales used in insurer-authorized illustrations meet the requirements of this regulation.

C. The illustration actuary shall:

(1) Be a member in good standing of the American Academy of Actuaries;

(2) Be familiar with the standard of practice regarding life insurance policy illustrations;

(3) Not have been found by the commissioner, following appropriate notice and hearing to have:

(a) Violated any provision of, or any obligation imposed by, the insurance law or other law in the course of his or her dealings as an illustration actuary;

(b) Been found guilty of fraudulent or dishonest practices;

(c) Demonstrated his or her incompetence, lack of cooperation, or untrustworthiness to act as an illustration actuary; or

(d) Resigned or been removed as an illustration actuary within the past five (5) years as a result of acts or omissions indicated in any adverse report on examination or as a result of a failure to adhere to generally acceptable actuarial standards;

(4) Not fail to notify the commissioner of any action taken by a commissioner of another state similar to that under Paragraph (3) above;

(5) Disclose in the annual certification whether, since the last certification, a currently payable scale applicable for business issued within the previous five (5) years and within the scope of the certification has been reduced for reasons other than changes in the experience factors underlying the disciplined current scale. If nonguaranteed elements illustrated for new policies are not consistent with those illustrated for similar in force policies, this must be disclosed in the annual certification. If nonguaranteed elements illustrated for both new and in force policies are not consistent with the nonguaranteed elements actually being paid, charged or credited to the same or similar forms, this must be disclosed in the annual certification; and

(6) Disclose in the annual certification the method used to allocate overhead expenses for all illustrations:

(a) Fully allocated expenses;

(b) Marginal expenses, or

(c) A generally recognized expense table based on fully allocated expenses representing a significant portion of insurance companies and approved by the [National Association of Insurance Commissioners or by the commissioner].

D. (1) The illustration actuary shall file a certification with the board and with the commissioner:

(a) Annually for all policy forms for which illustrations are used; and

(b) Before a new policy form is illustrated.

(2) If an error in a previous certification is discovered, the illustration actuary shall notify the board of directors of the insurer and the commissioner promptly.

E. If an illustration actuary is unable to certify the scale for any policy form illustration the insurer intends to use, the actuary shall notify the board of directors of the insurer and the commissioner promptly of his or her inability to certify.

F. A responsible officer of the insurer, other than the illustration actuary, shall certify annually:

(1) That the illustration formats meet the requirements of this regulation and that the scales used in insurer-authorized illustrations are those scales certified by the illustration actuary; and

(2) That the company has provided its agents with information about the expense allocation method used by the company in its illustrations and disclosed as required in Subsection C(6) of this section.

G. The annual certifications shall be provided to the commissioner each year by a date determined by the insurer.

H. If an insurer changes the illustration actuary responsible for all or a portion of the company’s policy forms, the insurer shall notify the commissioner of that fact promptly and disclose the reason for the change.

In addition to any other penalties provided by the laws of this state, an insurer or producer that violates a requirement of this regulation shall be guilty of a violation of Section [cite state’s unfair trade practices act].

If any provision of this regulation or its application to any person or circumstance is for any reason held to be invalid by any court of law, the remainder of the regulation and its application to other persons or circumstances shall not be affected.

This regulation shall become effective [January 1, 1997 or effective date set in regulation, whichever is later] and shall apply to policies sold on or after the effective date.

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Chapter 7