The SEC’s Office of Investor Education and Advocacy issued a bulletin to educate investors about how fees can impact the value of an investment portfolio. As usual, life insurance is often an overlooked asset in a client’s portfolio but is no less important than any other holding. As with anything you buy, there are fees and costs associated with those products and services. The SEC reports that “…fees may seem small, but over time they can have a major impact...” Along with the other factors the SEC urges you to “get informed…be sure you understand and compare the fees you’ll be charged. It could save you a lot of money in the long run.”
Keeping costs low is critical because every dollar spent on expenses is one less dollar available to purchase more death benefit. In fact, a recent study by Morningstar revealed “Low fees are likely to be the best predictor of a mutual fund’s future success”, and the same certainly holds true for life insurance products. While different insurers refer to different policy expenses in different ways, all policy expenses in all life insurance policies fall into the following 4 categories: 1) cost of insurance charges (COIs), 2) fixed administration expenses (FAEs), 3) cash-value-based “wrap fees” (e.g., M&Es) and 4) premium loads.
Cost of Insurance Charges (COIs) – The largest single cost in any insurance product is the cost of paying claims. Charges within life insurance policies collected to pay death claims are referred to as the Cost of Insurance (COI) charges. COI charges can account for up to 85% or more of the total policy expenses. Given findings from independent studies indicate there can be as much as a 40% deviation between best-available rates and average pricing terms and then also between average pricing and poorly-priced products (an 80% swing in total), measuring COI charges is an essential part of any policy review and/or suitability determination. In addition, some insurers "load" COIs to cover expenses not disclosed elsewhere (see discussion of "no-load" or "low-load" products under Premium Loads below).
Fixed Administration Expense (FAE) – FAEs are typically charged for expenses related to actuarial design, underwriting and new business processing, and service and administration, and are calculated as some fixed amount set at the time of policy issued either as a flat monthly charge (e.g. $10.00 a month), or in relation to the originally issued policy face amount (e.g. $1.00 per $1,000 of policy face amount). Also, with the advent of Guaranteed Universal Life products, FAEs often include the costs of death benefit guarantees. FAEs can also include contingent or back-end surrender charges deducted from the policy account value upon surrender or cancellation/termination of the policy. These surrender charges are calculated in relation to the initially issued policy face amount and can be as much as 100% or more of the planned annual premium.
Cash-Value-Based “Wrap Fees” – Cash-value-based “wrap fees” are insurance fees charged as a percent of policy account values similar to Fund Management Fees (FMEs) that are also charged as a percent of assets under management. However, these cash-value-based insurance fees are specific to the policy, and separate from and in addition to investment fees. The most common cash-value-based fee is the Mortality & Expense Risk (M&E) charge found in variable life products and intended to cover the risks assumed by the insurance company that actual cost of insurance charges and/or actual expense charges will be greater than expected. On the other hand, because investment fees are specific to the various mutual-fund-like separate accounts to which cash values are allocated, which almost certainly will vary over time, FMEs are less a determinant of life insurance product suitability and more relevant to fund selection within that product.
Premium-Loads – Premium loads are calculated as a percent of premiums paid in a given year and typically range between 0% and 35%. Premium-based charges customarily cover state premium taxes that average 2.50%, DAC taxes averaging 1.5%, and Sales Loads/Expenses typically ranging between 0% and 30%. Policies that are marketed as "no-load" or "low-load" policies do not disclose certain policy expenses or loads. However, because certain premium based loads still must be collected (e.g. state premium taxes, federal deferred acquisition costs (DAC) taxes, and the cost to distribute the policies), some insurers assess these costs inside "loaded" COIs. A load by any other name is still a load, no matter where in the expenses it is recorded.
While different insurers may use different words to describe the same type of policy expense, the expenses in all life insurance products are either a cost of insurance charges (COIs), a fixed administration expenses (FAEs), a cash-value-based “wrap fees” (e.g., M&Es) and/or a premium load.
The SEC recommends shopping around for the best price on any product or service. However, in the case of life insurance you should demand a Veralytic Report. The Veralytic Research consists of several measures of policy suitability including fees and expenses in an easy-to-read graphical overview, summarized by a simple star rating system that measures against five different categories of policy performance. The validity and utility of the research has been recognized by national industry publications as well as regulatory and oversight agencies.
Veralytic is simply the fastest, easiest, and most comprehensive and cost-effective way to independently verify to clients and their advisors whether or not the pricing and performance of existing or proposed life insurance is in their best interest. Veralytic is accepted for independent client representation, endorsed by the New York Bankers Association (NYBA) and compliant with industry regulations and established case law.
Use the Veralytic Reports to determine the appropriateness of pricing, the reasonableness of performance expectations for invested assets underlying policy cash values, and overall suitability for your (client’s) policies based on the 5 factors of suitability. Click here and get up to 3 Veralytic research reports under our NO-Risk trial subscription.
 “Low Fees Outshine Fund Star System” Wall Street Journal 08/09/2010
 ¹Tillinghast Towers Perrin study referenced in the May 2003 issue of Trust & Estates, CASCO survey reported in the April 1999 issue of Trust & Estates magazine, and research from TheInsuranceAdvisor.com database.