How good are the assumptions you're using?

Is there such a thing as a good assumption?

To build out a forecast, any forecast— weather, the end of the pandemic, retirement income projections — takes one thing that cannot be avoided: assumptions.

Now, there are good assumptions and bad assumptions.

Bad assumptions are when you make something “mean” something that doesn’t serve your purpose. Bad Assumptions ? Unsubstantiated Projections

Good assumptions, on the other hand, is an opportunity to show the world how you think. Is your thinking serving you and moving things forward or are they consuming you and holding you back?

What about the assumptions underlying a participating whole life illustration?

The one assumption that gets the most attention is the dividend interest rate.

As a CFP and a fee for service consultant, I am convinced making reasonable assumptions is fundamental to sound, long-term financial planning.

FP Canada provides a Projection Assumption Guidelines document.

 https://fpcanada.ca/docs/default-source/standards/2020-pag---english.pdf

 On page 1 of the Executive Summary, in large bold letters, they write…

 LIFE TAKES PLANNING AND IT STARTS WITH REALISTIC PROJECTIONS

"These Projection Assumption Guidelines are intended as a guide and are appropriate for making realistic long-term financial projections… Using numerous sources of data also eliminates the potential bias that may be created by relying on any single source."

So I applied their guidelines (I trust their guideline methodology, it’s the best guesses I’m aware of) to the par dividend interest rate (one significant component of future par policy performance).

A participating Whole Life dividend interest rate assumption calculation…

1. Fixed interest assumption: 2.9%
2. Canadian equities: 6.1%

If the par FUND is invested 50/50 between fixed interest and equities, we can calculate the CFP recommended assumption of future dividend interest rates:

4.5%... If current is 6%, CFP tells us the best dividend rate to use in our projections is current minus 1.5%.

I remember sharing my philosophy of using a calculated supportable illustration assumptions with an investment advisor who also sold cash value life insurance. She argued how important it was to be optimistic. When illustrating par with a prospective purchaser, she would suggest future dividend rates would likely be “higher” than current.

The life insurance advisor might be thinking… “If I show optimistic financial assumptions the family will be more likely to take action. My job is to get families to make financial decisions that are good for them. Nothing happens if they don't take action. They need life insurance. I can't predict what might happen in the future. They'll be better off because of me.”

The life insurance company might be thinking… “We see what our competitors are doing. The life insurance salespeople only sell the product that projects the biggest dollar amounts in the future. This is despite our consistent warnings to not use the illustration to determine which product is “best”. If we don’t use optimistic assumptions in our illustration projections nobody will buy it. Our competitors are going to do it, we must do the same. Thank goodness we can adjust future values later if we have to.”

An assumption is just a guess.

In science, an assumption is defined as an unwarrantable claim. The act of taking for granted, or supposing a thing without proof; a supposition without supporting evidence.

Assumptions are a necessary component of planning, but that doesn’t necessarily make any specific assumption useful. The illustrations provided by the insurance company provides projections based on both current and reduced dividend interest rates. That's good.

What dividend rate should you emphasize? What dividend interest rate do you show first (note... every insurance company's illustration package starts with current). Does that serve your purpose?

Now I get to rant.

Better decisions = informed assumptions

I look at assumptions as a necessary evil. But… if you want to help the families you serve make better decisions… it's important to know that one’s assumptions are true and are based on facts, so one can make the best possible choices. The best choices? Nice thought, impossible to do unless you have a crystal ball. But you have choices.

A new and improved advisor?

I see the rise of the new and improved advisor. Armed with the traditional skills of empathy and effective questioning techniques, we can fulfill an essential (and misunderstood) financial planning foundation that few other financial professionals truly understand the importance of. We can be the foundation of financial planning. Defensive financial planning vs offensive. Defence isn’t as popular as offence, but defence wins championships.

Life insurance advisors play the most critical role in the distribution of life insurance products. We have a duty of care that's difficult to define precisely. I don't want to mislead or make a mistake. I've seen far too many disastrous consequences. I think that’s why I use a reasoned and measured assumption when trying to figure out what to show. Most would say I’m being overly conservative. Especially in sales. Nobody will buy it. They say I should use an aggressive strategy. Show best case scenario. Promise everything and deliver what you can.

I think there’s an emerging market for a more conservative and measured life insurance professional. A professional who combines their people skills with technical skills. The information age is getting superb at exposing best practices. Who would you want to deal with?

I believe the professional who uses optimistic projections is transferring unnecessary risk to the families they serve. The purpose of insurance is to transfer risk to the insurance company.

Under promise and over deliver

Especially when trying to understand a page of numbers intended to show the future. My industry of life insurance sales suffers greatly from the repercussions of over promising.

I don’t think it will continue. People are smarter than that.

 Jeff Cait, MBA, CFP, CLU, CH.F.C., TEP

Independent Life Insurance Consultant | Fee-Only Consulting

[email protected] | www.jeffcait.com | 416.804.0433