Understanding—and Managing—the Impact of NLG Premium Payment TimingMany individuals were initially attracted to No-Lapse Guarantee universal life (NLG) policies because they were a good value in the declining interest rate environment. Clients also liked NLG because it offered coverage that could be “put in a drawer,” never to be thought about again—until it was needed. Today we know this is not the case. In fact, NLG may be a 50+ year commitment to paying on time, making full awareness of NLG parameters critical to proper management.

NLG policies offer guaranteed protection with no perceived performance risk. However, a substantial risk exists that the premiums will not be paid on time—which in this case means too late or too early. Missing the NLG premium due date can negatively impact the policy guarantee so it is essential to have a mechanism in place—or an insurance advisor with an effective service model—that avoids this misstep.

How It Works - Shadow AccountVirtually all NLG products offered today are Shadow Account based. The Shadow Account is an alternative account that acts very much like the Account Value (see Figure 1). If either the Account Value or the Shadow Account is positive, the policy remains in force. Flexibility is provided with regard to premium payments, duration of the guarantee, and amount of the guarantee. Unlike the Account Value, the underlying Shadow Account assumptions (i.e., charges and interest credits) are guaranteed—but the values and mechanics are “behind-the-scenes” and not accessible to the policyholder. Therefore only policyholder actions, such as variance in timing and amount of premium payments, may impact the Shadow Account and the resulting death benefit guarantee.

Figure 1: Shadow Account and Account Value Mechanics

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Premium Timing Impact on GuaranteeNegative Impact of Late Premiums—generally speaking, late premiums will reduce the Shadow Account due to lost interest earnings and the leverage of higher cost of insurance (COI) charges. The higher COI charge results from a higher net amount at risk—the difference between the death benefit and the Shadow Account value; the COI rate is applied to this higher amount, which reduces the Shadow Account. However, it is possible for a late premium to have a positive impact on the Shadow Account if a reduced premium charge is applied. Read more below regarding premium charges and the “Potential Negative Impact of Early Premiums.”

Positive Impact of Early Premiums—typically premiums paid earlier than scheduled will increase the Shadow Account due to increased interest earnings and the leverage of lower cost of insurance charges.

Potential Negative Impact of Early Premiums—there is, however, the potential for an early premium payment to negatively impact the Shadow Account due to a higher premium charge. Shadow Accounts typically have decreasing premium charge schedules by duration. The premium charge reduction can occur at any duration; but the largest reduction typically occurs from policy year 1 to year 2 (e.g., 10–15% first-year premium charge reduced to 5% for policy year 2). The greatest potential impact is for short pays (e.g., Single Pay or 10-Pay), which have larger annual premiums (versus a Full Pay, which pays a level annual premium for life).

Early Premium Timing Performance Examples:

• Level Pay funding—paying the second annual premium one month early results in the guarantee being reduced from lifetime (i.e., age 120) to ages 97–105; a 2–7% increase in future premium is required to restore the lifetime guarantee.

• 10-Pay funding—paying the year 5 premium one month early results in the guarantee being reduced from lifetime to age 98.

Premium Billing Notices and Grace PeriodsCarriers typically provide premium billing notices 20 to 30 days before the due date in order to help ensure the premium will be paid on time. However, an unintended consequence of early premium payment notices is that the payment is made before the due date (e.g., 5 days), potentially creating a higher Shadow Account premium load that may reduce the duration of the guarantee. Consequently, many carriers have also implemented premium “on time” grace periods where premium received 20–30 days before and after the due date is applied on the due date for Shadow Account purposes.

Note that some products were originally priced with no grace period. Although an “on time” grace period may now be in place, it is at the carrier’s discretion and may not be a part of the contract. Most policies indicate that premiums must be paid “as illustrated.”

Guarantee to Less than Lifetime and Catch-Up PremiumsFunding to guarantee less than lifetime, in order to reduce cost, may result in significant variances in catch-up premiums by product if the insured outlives the guarantee period.

As an example, product A may provide a 2% reduction in premium to provide guaranteed coverage to age 95 (versus product B) but product A’s catch-up premium to maintain coverage for ages 96+ is more than double that of product B. It may be worth paying the additional 2% up front in order to protect against an exorbitant catch-up premium if the insured outlives the original coverage period.

Stress-testing various scenarios before placing the insurance is vital to avoiding this issue.

NLG Premium Payment Best Practices • Pay on time—research and pay within the premium due date grace periods (generally, as close to the due

date as possible).• Understand the impact of premium variances (timing and amount) before implementing a premium

Understanding—and Managing—the Impact of NLG Premium Payment Timing (continued)

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Understanding—and Managing—the Impact of NLG Premium Payment Timing (continued)

change—request an in-force illustration that will show the impact on the guarantee.

• Ask your advisor for annual in-force policy reviews and take appropriate action when needed—having your insurance advisor review annual policy statements to assess the guarantee and run in-force illustrations when appropriate (at least every two years) to assess adjustments (e.g., catch-up premiums or reducing the face amount to reestablish guaranteed coverage for intended duration) that may be required.

• Negotiate with carriers—carriers will generally make the policyholder whole when an early premium payment results in an unintended negative consequence for the policyholder; working with an insurance advisor who maintains strong relationships with carriers is helpful in these instances.

• Consider shorter pay funding—consider a 5-Pay or 10-Pay versus longer pay periods where there are more opportunities for the premium to not be paid on time.

• Work with advisors or trustees who add value—just as many rely on attorneys, CPAs, and other professional advisors for expertise and service, engaging an insurance advisor who understands NLG product mechanics and offers a service platform designed to address the parameters of NLG will likely have a positive impact on the success of your policy.

To learn more, please contact a member of M Financial’s Product Management team.

Wayne Tonning 503.414.7430 wayne.tonning@mfin.com

Dennis McMahan 503.414.7358 dennis.mcmahan@mfin.com

Jennifer Lachnite 503.414.7348 jennifer.lachnite@mfin.com

Derrick Hanson 503.414.7234 derrick.hanson@mfin.com