Prudential Financial, one of the largest life insurance organizations in the U.S., sells no-lapse universal life policies that are competitively priced in today’s market. However, if you follow the premium schedule that the agent proposes, you will probably be a fool.
The single-life version of the product is called PruLife® Universal Protector; the second-to-die version is PruLife® SUL Protector. Both versions have a similar design, with two no-lapse guarantees.
The Limited No-Lapse Guarantee applies for the first five policy years. It uses a variation of a stipulated premium design. The guarantee is in effect if the paid premiums accumulated at a specified annual interest rate, such as 3%, exceeds the applicable number in the Table of Limited No-Lapse Guarantee Values. This is equivalent to compounding an implicit level monthly no-lapse premium at the specified rate and then comparing the compounded values for the actual and implicit premiums.
The Rider to Provide Lapse Protection applies after the fifth year, and it uses a shadow account design. This guarantee is in effect each month if the No-Lapse Guarantee Value is greater than zero.
On each monthly date, the No-Lapse Guarantee Value is equal to:
prior month’s value
+ premiums received
– premium charges
– default charge
– administrative charge
– cost of insurance
The default charge applies only if you allow the No-Lapse Guarantee Value to become zero or negative, so it is avoidable.
All of the factors that determine the No-Lapse Guarantee Value are stated in the contract, and Prudential cannot change them after issue.
Here is some key information from a client’s policy that I recently reviewed:
- The no-lapse premium charges are 28.00% in Years 1-5; 9.25% in Years 6-10; and 0% thereafter.
- The no-lapse interest rate is 1.60% in Years 1-4; 3.00% in Year 5; 6.75% in Years 6-7; and 7.00% thereafter. (For the Limited No-Lapse Guarantee, the interest rate is 3%.)
- The no-lapse cost-of-insurance charges are very small during the first 10 years; the interest-rate equivalent is less than 0.1% each year.
- The implicit monthly no-lapse premium for the Limited No-Lapse Guarantee is about $512.
- The monthly no-lapse premium to age 121 for the Rider to Provide Lapse Protection is $701.
- The commissionable target premium is about $8,400.
- The proposed premium schedule is about $17,400 a year for 10 years.
Are you a fool if you accept that proposal? Yes, you are.
You certainly have to pay at least $512 each month (or $6,060 each year) during the first five years, because that is the minimum premium that will satisfy the Limited No-Lapse Guarantee.
Any premium above that will incur a premium charge of 28%. That charge drops to only 9.25% in Year 6, so you are losing 18.75% of the excess premiums. That loss is partially offset by the interest (1.6% for four years and 3.0% for one year) and by the reduced cost-of-insurance charges due to the reduced net amount at risk (equivalent to less than 0.5% over five years).
If you are still alive after five years, the result of following the agent’s proposal is a loss of about 15% of the excess premiums; in other words, you would have the same No-Lapse Guarantee Value if you paid the minimum premiums, spent about 15% of the excess on fun stuff, and then put the remaining 85% into the policy at the beginning of Year 6.
If you die during the five years, all of the excess premium is forfeited.
Prudential is aware that its declining premium charge has the potential to create customer dissatisfaction. The contract has this provision: “For any premium we receive in the 21-day period preceding a contract anniversary on which the initial or ultimate rates decrease, we will subtract a no-lapse charge for sales expenses no greater than the amount we would subtract if that premium were received on the contract anniversary.”
I have seen no warnings in the sales illustrations or other product materials that address the implications of the no-lapse guarantee design for choosing a premium schedule.
The agent’s compensation is also misaligned with the optimal premium schedule, because the commissionable target premium exceeds the Limited No-Lapse Guarantee premium. That means that the agent probably gets paid at least 50% of the excess up to about $2,300 in the first year.
It takes a village to turn customers into fools. You need actuaries to create the product and state insurance regulators to approve it. You need agents to sell it. And you need accountants, attorneys and financial advisors to go along with the proposals.
But now you know how Prudential invites you to be a fool and how to decline the invitation.