When an engineer designs a bridge, tests are run to assess all of its critical parts and systems—suspension deck, cables, pylons and much more. These tests aren’t intended to assess the bridge’s health and performance solely under normal conditions; rather, they measure its ability to withstand extreme conditions as well—e.g., hurricane-force winds, heavy rain and flooding, severe temperature variations. “Stress tests” like these not only indicate a bridge design’s overall expected performance but they pinpoint specific areas of weakness, which, in turn, helps the engineer make critical adjustments that can help ensure safe and reliable operation.

An insurance policy stress test for CPA clients serves a similar function. As part of a forensic audit conducted by an experienced insurance professional, an insurance policy stress test utilizes analytical information about a given life insurance policy in order to put various assumptions to task—specifically, mortality, expenses and interest/dividends. Insurance policy stress tests measure insurance policy performance under conditions beyond current advantageous assumptions.

At American Business, we believe insurance policy stress tests offer huge value for policyholders of CPA clients. Why? It really boils down to cause and effect.

Many people purchase life insurance, then forget about it—out of sight, out of mind. This invites serious risk, for many factors can affect policy performance, unbeknownst to the policyholder. Even the timing of premium payments is crucial; one day early or one day late can adversely impact performance. Extrapolate that out to one week, one month or more, and the negative impacts grow evermore profound.

When we at American Business conduct a forensic insurance audit[DW1] , we include a policy stress test as a key part. This test unfolds in three primary phases:

Phase 1: We put the client’s policy under a microscope and examine its performance during the normal course of action. This helps us first understand existing issues, regardless of conditions—i.e., is undue stress being placed on this policy due to inadvertent timing issues, payment issues, insurance company changes to mortality or expenses that were not conveyed properly? Each of these variables is tested, assessed and analyzed. In the end, this knowledge provides a baseline understanding of the extent to which the policy is currently stressed.

In the course of performing Phase 1 analyses, we often uncover several common issues:

• The guarantee may not be as long on the policy as was originally desired
   
• The cash value may be growing at a slower rate than the policyholder desired
   
• The policy won’t last as long as the policyholder desired
   
• The policyholder can’t take out as much money as he/she thought they could

Phase 2: We approach the insurance company and request specific information in specific formats. Typical policyholders have no idea what information to request to measure their policy performance, or even how to phrase the questions so that insurance companies respond properly. Inquiries like these are sophisticated in nature and call for experienced professionals to lead the charge. This isn’t so much reflective of exceptional brilliance on our part, but rather, the lack of motivation by insurance companies to provide sufficient information in a timely manner. After all, if a policyholder is in good health, he/she can exercise a 1035 tax-free exchange to a better policy. That’s not in the insurance company’s best interests, so many providers are late in providing this information to outside sources—even those with proper authority and authorization. And, when they do provide the information, it’s not presented in a way that’s meaningful or bottom-line relevant to non-professionals.

Next, we ask the insurance company to run the insured’s policy at the current assumptions – current interest, mortality and expenses – and we may also ask them to drop their assumptions – particularly their interest or dividend assumption – by 50 or 100 basis points. That allows us to examine the performance of this policy under minor stress.

We then ask the insurance company to provide in-force illustrations, or runs, on an insured’s policy in the worst-case scenario under a guaranteed assumption. Specifically, we request in-force runs at the pure guarantees on the contract, in case the insurance company decides to change its practice relative to charging mortality and expenses and interest to the client.

Finally, in Phase 3, we analyze the results from these exercises, plug any information gaps that may exist and begin to connect dots that can lead to (1) an honest assessment of the current policy’s suitability, and (2) potential options for optimizing the current policy’s performance, or pursuing other avenues. Some of the questions we ask include:

• If the policyholder stops paying the premium, will that policy last as long as was originally intended?
   
• Does an opportunity exist for the policyholder to cut their premium payments? (If so, the insurance company likely won’t alert the policyholder to this fact.)
   
• Are there positive or negative tax implications of this policy? For example, is the policyowner running the risk of having that policy become a modified endowment contract (MEC)?

Trusted Insurance Partners Can Engineer Policy Stress Tests

At American Business, a key element of our mission is to educate trusted partners and their clients on life insurance matters that can better inform their decision-making when it comes to life, long-term care and disability insurance protection.

We hope this article helped you understand life insurance policy stress tests—what they are, why they’re conducted and the value they provide your clients. At American Business, we appreciate the opportunity to bring these important issues to light, and help you and your clients navigate the complex and evolving life, long-term care and disability insurance landscape.