In the wealth management world, basis points mean everything. Hedge funds may charge 100 to 200 basis points plus a performance fee. Fund of funds typically charge 50 to 100 basis points plus a performance fee. The model for wealth management firms could be 50 basis points for managing a $10 million portfolio.

Based on our observations, we know wealthy individuals and families pay close attention to basis points. We have all seen administrative platforms trying to find greater efficiencies for their business model so they can lower their basis point charges. It is not uncommon for an asset manager to be fired over 5 to 10 basis points – either via performance or administrative costs. The bottom line is this: basis points matter.

Life insurance is no exception.

There is an opportunity to have meaningful basis point reductions inside your life insurance policy. Many affluent families are unaware of the impact lower basis point charges can have on this asset class and how to take advantage of the possibility.

The potential solution can be found in the genesis of life insurance products designed specifically for the affluent buyer and the ability to segment experience to create a separate risk pool for those insureds.

In 1978, a group of life insurance advisors approached product manufacturers (i.e., carriers) with an intriguing opportunity. These advisors served wealthy individuals who exhibited superior experience in three areas at the heart of life insurance product design and pricing. These affluent clients had better mortality (they lived longer primarily because of access to the best healthcare), they purchased larger amounts of insurance (which created efficiencies via lower unit costs for the carriers), and they kept their policies in force for longer periods of time (because they purchased life insurance for a specific need and have the resources to pay the required premiums). Based on these characteristics, these clients deserved to be treated differently, specifically with products priced with these advantages.

The carriers listened and agreed the opportunity was intriguing. But they needed proof to justify the lower pricing for these clients.

So the advisors began collecting data—through a reinsurance company they created with their own capital—that proved the original theory: wealthy clients demonstrate experience characteristics—mortality, expense, persistency—that justify lower pricing.

These advisors now have several decades of data showing that:

• the mortality of the affluent market is 30% less than that of the generally insured public;
• the persistency of the affluent market is 60% higher than the generally insured public;
• the average policy size of the affluent market is seven times greater than the generally insured public, which creates expense efficiencies for

This led to the creation of life insurance products that recognize the superior experience of the affluent market segment with institutional pricing that was superior to the retail products available to the general public. But these advisors didn’t stop there.

With the database of experience—collected through the reinsurance company—the advisors had unique insight on product profitability. Typically, when product profits exceed expectations, carriers keep the money and create new versions of products with better pricing (based on the better mortality). These advisors saw an issue with this. Why wouldn’t you reward the current policyholders who created the value?

When life insurance companies design a product series, they typically seek to earn a profitable return. A large influence on this is the mortality of the insurance pool. If the pool of insureds lives longer than originally forecast, then the carrier is taking in more premiums over a longer period of time. In addition, the carriers are also subtracting monthly mortality and expense charges from the cash value portion of the policies for longer periods of time. Bottom line—better mortality results in more profit for the carriers.

When this occurs in the retail market, the carriers keep these excess profits and they may create a new version of the product. This new version will have better pricing since it reflects the newer mortality experience of that particular carrier’s block of business. So policyholders of the new version get the benefit of the more profitable experience generated by policyholders of the previous version. To take advantage of the better pricing, policyholders of the original policy would have to surrender their policy, go through underwriting again (which may be an issue based on changes in health), and buy the new version of the product.

Again, the advisors saw an issue with this and presented a compelling case that a portion of the profits in excess of original projections should be returned to existing policyholders. This return of profits manifests itself in the reduction of costs to the existing policy holder.

We are also seeing persistency bonus credits where policy holders may get as much as a 50 basis point increase in their return for staying on the carrier’s books for a long period of time. All of this can represent permanent reductions in the internal costs of the products.

The impact of lower charges can be significantly positive for the policyholder. Take the example of a 65 year old male who obtained an institutional policy in June 1997. The policy was designed to have an 8% net rate of return with a premium outlay of $85,985 for ten years. During the ensuing years, the policy experienced three cost of insurance charge reductions and three reductions in asset-based charges. As a result, instead of requiring a premium of $85,985 for 10 years, the same objectives could be achieved with a premium of $74,065 for 10 years. This represents a 14% premium reduction.

Another way to look at it is instead of needing an 8% net return, the policy needed only a 6.68% net rate of return to achieve the same result. This represents a 132 basis point difference. Imagine the impact this would have for a family with significant life insurance holdings.

While past experience is no guarantee of future performance, the principals are solidly in place. From the pricing of the product at the outset to the in-force management of an existing policy when even more favorable experience emerges, these advisors established a level of client advocacy that remains unmatched in the life insurance industry.

When evaluating product options, in some instances a wealth management lens can be a good way to view your life insurance portfolio—particularly when issues of efficiency and effectiveness are important to a family. Affluent individuals can take advantage of their socio-economic demographics to join a risk pool with an opportunity to participate in future mortality gains and expense reductions. As we have seen, sometimes the return of these basis points can have  an important influence on the performance of the policies. This is critical when considering the various factors affluent families evaluate when purchasing life insurance. Given the opportunity, affluent families often, if not always, want the opportunity to chase those basis points.