Historic Volatility Calculator (HVC) Tutorial (Ver )

Transcription

1 Historic Volatility Calculator (HVC) Tutorial (Ver ) Welcome to the Historic Volatility Calculator (HVC) provided to members of the Society of Financial Service Professionals by Hause Actuarial Solutions, LLC and Ethical Edge Insurance Solutions, LLC. This program is being made available as a member benefit and there is no charge for the user s license. When you click to download the program, accept the software license agreement. The download will be on the next screen. That s it! The following is meant to be a tutorial for use. Because the HVC is provided at no cost to Society members, we are not able to provide telephone support. If you are having difficulty installing or running the program, please take advantage of the HVC e-group to ask questions or provide suggestions from your own experience. We actively monitor the HVC e-group, but this is also intended to be a community-driven process! Installation This is a standard executable program intended to run under Microsoft Windows XP or Windows 7. It has not been certified for Windows 8, but we understand it does work in that OS. MAC users will need to install HVC in a Windows virtualization environment such as Parallels or VMware Fusion. After downloading from the Society s website, install HVC as you would any other program. DO NOT RUN FROM THE WEBSITE! If offered the choice DOWNLOAD the program and run it from your download folder. Re-boot your computer if instructed following the program installation. In XP - if a desktop icon is not automatically created by the installation, you can manually create a desktop shortcut from c:\program files\has Files\bin\IHT_Calculator.exe. Directions for making a Windows 7 shortcut => Directions for making a Windows XP shortcut => If you have any difficulty with this, ask for assistance from anyone in your family under the age of 10!

2 Getting to the good stuff Let s consider a typical situation of a client s thinly-funded 15-year old variable universal life (VUL) policy and your concern that the volatility of the Mama Bear and Papa Bear markets will likely shorten the lifespan of the policy if only the current planned premium is paid. You ve requested an In-force Illustration at the same 10% assumed average return as was used to calculate the original planned premium, but the resulting in-force illustration suggests the damage from the bear markets may not be as bad as you had thought. A bullet dodged? Let s find out! Details for an existing 15 year old VUL: 37-F-Preferred non-smoker VUL policy issued 3/1/1999 for a $2,000,000 death benefit with a planned premium of 10% average return assumption. Since then, the client s asset allocation has continued to be in an S&P500 Index Sub-Account. The original sales illustration suggested an account value at the end of the 15th year of $91,264, but in actuality, the current account value as of 3/1/2014 is $84,298. Not withstanding the lower-than-projected value, the in-force illustration indicates that coverage will last until her age 92, two years beyond average life expectancy. So what is the problem? Sub-accounts in variable universal life policies don t behave according to average rates of return; they re volatile and they follow the specific asset allocation selected by the policy owner. Annual (calendar) returns have vacillated between plus 32.4% and minus 37.00% in the last 15 years, and that volatility exposes the potential for unplanned increases in net amount at risk. The rise of net amount at risk during market swoons can cause rapidly increasing costs-of-insurance (COI) to eat away at the account value, for which future sub-account returns may be insufficient to avoid policy lapse in light of the negative spiral of decreasing account values paying for everincreasing net amounts at risk. Thus, we need a different way to view the possibilities than a deterministic policy illustration that projects a constant return assumption. Solution: The historic volatility calculator (HVC) calculates volatility for the chosen asset allocation and then runs 1000 hypothetical illustrations using the illustrated planned premium. The number of successes (illustrations reaching and exceeding age 100) are tallied and converted into a Success Probability. Is 31% acceptable to YOU? Or an earliest lapse of age 71? Probably not! In most cases, anything less than 80% Success Probability will be unacceptable to a client, and these days we re hearing more 90% and even 100% responses when we ask the client to express their personal probability tolerance for life insurance. 2

3 Assuming the client specifies a 90% minimum probability of success for the situation described above, the historic volatility calculator (HVC) produces a Correcting Premium recommendation in this case increasing the planned premium from $7,250 to $21,569. This is the estimated revised funding premium that will meet the 90% statistical requirement. Note that this is not a precise amount and it s not a guaranteed premium in any sense of the word. But it is a reasonable guess with a more sophisticated approach than a constant average to help set the client s expectations more realistically - and to set the stage for ongoing management. Press the calculate button again; you ll get a slightly different result. Is this a problem? NO that s the nature of unique randomizations. Notice that you also get some extremely valuable information in the form of a Correcting Illustration Rate. In this case, the HVC has calculated that if you go back to the insurance company and ask for an inforce illustration using (in this case) 6.33% as the VUL gross crediting rate (rather than 10%), you ll get a number very similar to $21,569. Incidentally, the closer the Deviation calculation is to 100 the closer the insurance company s revised planned premium will approximate what s calculated here. More on this in a few pages. 3

4 How did we get there? Using the HVC - Insured Information Tab Use each drop-down window to enter the appropriate input data about the INSURED. Note that the program does NOT store or save client data, and the Client ID is not reflected in the 1-page summary report. If the policy type had been Survivor - the second set of data input windows would have allowed you to indicate the second age, gender and rating. In this example of assessing an in-force policy, use the attained insurance Age. Note that Ratings are offered in Preferred, Standard, and Table 4 ( rated ) with Non- Smoker / Tobacco variations. Use the rate class that is closest to your client s actual rate class in the policy being assessed. The historic volatility calculator (HVC) is best used for Variable UL (VUL) - one life and survivor - and Indexed UL (IUL) - one life and survivor. However, in today s low interest rate environment for traditional UL, there is very little current or anticipated undulation in crediting rates. The recommended use of the UL module, then, is to estimate the difference between projected current policy expenses and the HVC's "benchmark" (Product Standard) expenses for Universal Life and to use that information for a Correcting Premium. 4

5 Using the HVC - Policy Information Tab Face Amount: direct input in our sample case - $2,000,000 Premium Years is the number of years the Premium will be paid in the future. Our insured s current age is 52 so to continue paying premiums until age 100 results in an input of 48 more years which is the calculated default based on the insured s age. If the premium is to be paid for fewer years, indicate the number in this field. Premium is the parameter to be tested within the 1000 randomized hypothetical illustrations - which we now wish to test 15 years after issue. Interest Rate is the crediting rate of the in-force-illustration you are testing. In this case we ll use the originally illustrated gross VUL rate of 10%. If the specified policy had been an IUL, the historic volatility calculator will automatically choose a one-year pointto-point S&P500 Index, defaulting to a 0% guaranteed minimum and a 100% participation Cap of 10%. You may adjust the guaranteed minimum rate up to 3%, relating to the specific illustration you are assessing. The specified interest rate of the in-force illustration will NOT be used for anything but calculating Deviation which you ll learn about shortly. Confidence Level is the specified Success Probability objective in this case 90%. 5

6 COI Multiple: 100 represents the Policy Standard for this policy style (an actuarially determined, illustratable policy that you can t buy but which represents appropriate long-term pricing). 110 adds 10% to all COI expenses; 90 subtracts 10%. Investment Dataset (VUL only): Use Historic 100/0 or 80/20 or 60/40 OR specify the percent of Equity in Custom Historic Mix. Here, you have the option to grade the current mix in the Custom window to a different allocation over a defined period of time in the pop-up window that will appear when you select Custom Historic Mix. Set the ultimate percent stock to the same value as Initial if you don t want to grade the asset allocation. For this variable universal life (VUL) example we have used Historic 100/0 because the client is still comfortable with an all equity allocation. In time, however, the client might come back to the option of managing the policy with a lower equity component, especially as the client gets older and is generally more risk intolerant.. Hint: do NOT use 40-year data. While included as selectable data sets, 40-year data sets are used for testing and are not appropriate for the volatility tests performed in the HVC. Investment offset (VUL and IUL): You can optionally specify an annualized reduction in historic returns for any asset allocation in a selection range from 50 to 300 basis points. Earnings Minimum (IUL): The HVC defaults to 0% for the minimum guaranteed crediting rate. If the illustration you are assessing has a guarantee greater than 0% and equal or less than 3%, you can make that adjustment in this field. NOTE: if the adjustment is less than 1%, you will need to use the following convention: if the guaranteed minimum is.5%, adjust the default to read.005 % Yes, we know that s not mathematically correct except in the world of data input. We re working on a better way to handle this, but for now, use this convention! Amounts of 1% up to 3% can be adjusted the regular way in this data field, i.e. 1.50%. Calc Method: indicate endow or 0 for the Sustain Age. Sustain Age: Life Expectancy (LE), Life Expectancy +5 years, age 100, or Custom Age up to 100. Selecting the latter will reveal the client s peer group s average life expectancy (LE). 6

7 Using the HVC - Policy Options Tab The historic volatility calculator (HVC) assumes a level death benefit. You can specify an increasing death benefit for a certain length of time - up to age 100 by checking the first box and entering your desired values in the two boxes to the right. If this had been an assessment of a NEW policy and there had been exchange $$ or a first year pour-in, you would check the second box on the menu and indicate the net amount to be added in year one in the space to the right. This amount is subject to Product Standard first-year premium charges. However, since our example is an assessment of an EXISTING policy with a level death benefit, the first two boxes are left blank and the third box is checked. We have specified the $84,298 Account Value (not surrender value) in the space provided and the Year of issue, 1998 in the space to the right. This amount is not subject to first expense year-charges in the HVC calculation. WARNING: If you do not specify the year, the program will CRASH and you ll have to start all over again! By checking the fourth box on the menu you can enter the amount of future Withdrawals beginning at a certain age for specified years. Loans are not accommodated. Make certain to CHECK the appropriate menu box before you input a value - or the inputs to the right will not be saved for the calculation. 7

8 Using the HVC Deviations Tab The Generic Product Standard is the way we normalize the difference in policy expenses that are subject to change in the future. The Product Standard is an average of expenses underlying currently available policies in the 3 universal life styles therefore the HVC reflects the average of what company actuaries have determined are expenses that can be reasonably expected in the future. Deviation allows you to determine if the insurance company-provided illustration is using expense assumptions that are lower or higher than the standard which makes them appear more (or less) competitive than may be realistic. The historic volatility calculator (HVC) will calculate the gross deviation of the universal life in-force-illustration or new policy illustration from the Generic Policy Standard. Simply choose a future age in the Attained Age input field (we recommend the year of lapse or age 100 if the illustration sustains that long) and the projected account value from the in-force or sales illustration for that year in the Cash Value input field. 8

9 Using the HVC Results Tab OK it s almost Show Time! But don t hit that CALCULATE button until you confirm that you correctly entered all of the information in all of the previous tabs! When all input tabs have been reviewed and verified, NOW click on the Calculate button and watch the calculator go through one-thousand different possibilities of variable returns as described below under Success Probability. 9

10 Using the HVC Results Tab What is shown in the list of information to the left of the calculator button includes: Target Age: the Sustain Age you specified in Policy Information Life Expectancy: The HVC calculates average life expectancy based on age, gender, and rate class input by you under the Insured Information tab Now, here comes the HVC-provided good stuff!! Success Probability: In VUL and IUL universal life assessments, the HVC randomizes historic returns in the chosen asset allocation (herein 100% equity and 0% fixed) or Index parameters for IUL on a monthly basis for the number of months in the future that will take the policy to and beyond the insured s age 100. In this case, that s a VUL dataset of 576 historic monthly returns for an attained age 52 year old, or 48 1-year Indices in an IUL. This randomization focused on the test premium determines the number of successes out of the 1000 hypothetical illustrations and turns that into the Success Probability. 10

11 In an IUL assessment, the HVC randomizes the historic 1-year point-to- point returns of the S&P500 Index (without dividends) within 1000 hypothetical illustrations. That s approximately 250 market days per year times the number of years between current age and age 100. If the case we ve been processing in this tutorial had been an IUL for our (attained age) 52-year old, that results in approximately 12,000 (48 x 250) pointto-point historic returns that will be randomized against the specified premium. Note that the resulting randomization is then modified by the 0% (or specified up to 3%) guaranteed minimum and 10% CAP with 100% participation. Again, the Success Probability is the number of these hypothetical illustrations out of 1000 that sustain to and beyond age 100. OK let s evaluate what we know so far! Question 1. Does the calculated Success Probability make sense to you? Our answer in the VUL example we ve been reviewing YES! Our thinking went like this: we entered the 10% crediting rate used when the policy was issued in We know there are VERY FEW combinations of return that could possibly have provided that average return during those years especially with the two major stock market downdrafts in the last decade. Also, we knew from the scenario details that the policy was already behind original illustration expectations the illustrated account value $91,264 vs the actual account value of $84,298. Question 2. If you hit the calculate button again, will you will get the same Success Probability? Go ahead - try it. No it s slightly different! Consider what the HVC does again under the sample Success Probability above monthly returns that will be randomized... It is a statistical impossibility that HVC could come up with the identical 576 monthly historic, volatile returns as an old style deterministic linear illustration. Stochastic Analysis (Monte Carlo is its more popular name) provides credible, statistical information in a non-linear world. Earliest Lapse: Unlike a deterministic illustration, there is a distribution of lapses that will occur beginning with the first lapse. The HVC tells you the age at which this first-outof-1000 hypothetical illustration lapses. Lapse Distribution (LOW/HIGH) shows the rolling 5-year age range in which the most number of lapses occur in the randomized 1000 hypothetical illustrations. Deviation: There will always be a value shown here, but it is only valid if you specified a cash value amount at a future age in the Deviation tab. If Deviation is over or under 100 by no more than ± 15, we believe Deviation is within a comfortable range of expected differences in product design. Deviations of 30% or more (above or below 11

12 100 ) are not uncommon, but suggest the possibility that the product design is different from the products from which we developed the policy standards. It might also suggest that at some point, future management may decide to migrate to the mean of actual experience. Correcting Premium: this is the estimated new planned premium that will produce the specified Success Probability - which we indicated when specifying a Confidence Level in the Policy Information Tab, right side, second input field. Correcting Illustration Rate relates to the Correcting Premium described above. If the Deviation is between 85 and 115, the Correcting Illustration Rate gives you a value to use as a revised interest crediting rate in the original illustration software from which the sales or in-force illustration was produced, and the newly calculated planned premium will be approximately the same as the Correcting Premium. If the Deviation is lower than 85 or higher than 115, the revised planned premium calculated in the carrier s illustration software could be substantially different than the Correcting Premium. Print a one page report of the HVC data input and calculation results: Why print a copy? Because when you close the HVC nothing will be saved. Prudence says PRINT! Print a one page report of the HVC report: Why print a copy? Because when you close the HVC nothing will be saved. Prudence says PRINT! 1. Click your mouse on FILE and select Print Preview. Then Select Print All in the page s menu bar. 3. To return to the calculator, click the X in the upper right-hand corner of the program screen to close the page. 12

13 Input Window Details Insured Information Tab Click on the open window arrow and select the policy (and individual/survivor version) you are assessing: Select gender: and select rate classification: 13

14 Policy Information Tab Select the calculation method and the age to which the calculations should be made For more choices, use the Custom Age option Note that this tool does not make calculations beyond age 100, and will not accept user input greater than age 100. Final Notes: 1. The example shown in this tutorial demonstrates the ability to perform a deeper dive assessment of an in-force illustration. The HVC can also be used (we d say should be used) to suggest an appropriate funding premium for a new policy based on the client s consideration of a sufficient Success Probability. 2. While formal program support is not available, we hope to inspire a community of users sharing their experience at the Society s HVC e- Group. You can access this e-group from the software download site: 14

15 Finally, of course there s the obligatory warnings from our lawyers: 3. Neither the Society of Financial Service Professionals nor Hause Actuarial Solutions, LLC nor Ethical Edge Insurance Solutions, LLC provides investment advice. General discussions regarding risk tolerance or asset allocation should not be construed as investment advice. Users should at all times seek investment advice from advisers who are licensed and knowledgeable in the area of investments, investment strategy, and investment implementation. 4. The information contained herein is statistical in nature and is not intended as a prediction of outcome or a commentary on any particular insurance company or its life insurance products. 5. As with all valuable property, life insurance should be properly acquired and actively managed over the insured s lifetime using a professional life insurance agent. Neither the Society of Financial Service Professionals nor Hause Actuarial Solutions, LLC, nor Ethical Edge Insurance Solutions, LLC are licensed agents, nor do any of these entities sell life insurance or serve as an insurance agent. 15