Avoid the insurance illustration trap

By Ginger Applegarth

A life-insurance-policy illustration is a set of projections, prepared by the actuarial department of an insurance company, that shows how your policy will perform over your lifetime.

It includes financial projections for each year. If it's a term policy, the projections extend to the date the policy ends. If you chose permanent life insurance, the projections stretch beyond your 100th birthday.

For term insurance, a policy illustration usually shows at least three things: current and maximum premiums for each year; total premiums paid up to that year; and each year's death benefits. If your policy has "re-entry" provisions for certain years -- requiring you to qualify for the benefits through a physical exam, for example -- there are columns telling you the premiums if you passed ("re-entered") or failed the company's medical requirements.

Sounds easy, doesn't it? If you are stopping at term insurance, you are in luck. If not, be prepared for a shocker when you take a look at your first policy illustration for permanent life insurance.

An illustrative nightmare

Permanent insurance illustrations are complicated enough to make you want to give up the buying process altogether. The typical term insurance illustration runs two or three pages and contains perhaps 100 numbers. For permanent life insurance, the illustration can run 10 pages with 1,000 numbers. Further complicating this numerical morass: Except for the numbers listed in the "guaranteed" columns, the actual payout for virtually every number you see is bound to be higher or lower than projected.

Why are permanent life insurance illustrations so unreliable? Obviously, the company has to project dozens of years into the future, estimating how well it will invest its portfolio and what its expenses and mortality costs will be. So, except for guaranteed premiums, cash value and death benefits, the future payouts you see in the illustration are pie-in-the-sky figures.

Many reputable agents tell their clients to forget the nonguaranteed numbers altogether and to consider them as icing on the cake (the cake being the guaranteed part). But some agents don't, and they brandish the illustration as their primary sales weapon in the battle to get your business.

Video: How much life insurance is right?

The interest rate 'sting'

Life insurance agents often sell particular products by touting the company's "current interest rates" and "current dividend rates." It is tempting to just buy the policy with the highest current rate.

The problem is that current rates are usually guaranteed for only three to 12 months, and some of the life insurance companies with the highest current rates have the most expensive policies in the long run.

Continued: Making illustrations work for you

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