Do PUAs grow less efficient over time? Should clients buy new policies to better utilize PUAs?
As you know, in the early months and years of a whole life policy, the PUAs are more efficient than the base premium in generating cash value for the policy. While the base premium alone can take years to generate a positive internal rate of return where cash value is concerned, the PUAs are converted to cash value right away, which increases the efficiency of the cash value overall.
However, after 5-7 years of funding a whole life policy, the impact of the PUAs appears to lessen. Illustrations of a policy funded with maximum PUAs vs. no PUAs at all show that, several years into the policy, the PUAs no longer have a dramatic effect on the IRR of the policy.
For instance, in one example, adding PUAs to a 12k premium for the first five years increased the internal rate of return on the net cash value in the 12th year from only 0.57% (no PUAs) to 3.29% (with 5 years of PUAs) – a difference of 477%!
Note: We put “1” into the Years box, rather than “5” because this demonstrates the immediate overall increase, rather than the average difference spread over time.
However, when the PUA is paid for 10 years, the PUAs only bring the IRR up to 3.52%. The increase from 3.29% to 3.52% is only 6.99%. In other words, the first 5 years of PUAs seem to be more efficient than the second set of 5 years.
Do PUAs Become Less Efficient Over Time?
So why are we seeing this discrepancy? Are the PUAs really becoming less efficient?
And if they are, what should the client do? After the initial years of the policy, should a policyholder start a new policy and put their PUAs into the new policy to increase the efficiency of the PUAs? Is the “old” whole life policy not the best place for the client’s PUAs?
To test this, let’s compare the effect of transitioning the PUAs to a new, second policy after 5 years to see if the average internal rate of return (of the policies combined) is greater.
What Todd discovers is this: the combined IRR of both policies when the PUA stays with the first policy is 2.34%, while the IRR of both policies when the PUA shifts to the new policy is a nearly identical 2.32%.
Todd also discovers virtually no difference in internal rates of return when the policies are extended to age 70. (The results are 4.76% and 4.75% IRR of the combined policies when the PUA is shifted from one to the other.)
The Conclusion?
Starting a new policy is not necessary to increase the effect of a PUA.
Therefore, there is no numerical reason to start a new policy to “increase the efficiency of the PUA.”
However, the numbers alone don’t always tell the whole story.
There may be other reasons to start a new policy. As Todd mentions in the video below, starting a new policy creates a new “bucket” into which cash can be stored, which may be very beneficial for the client. Each new policy creates an opportunity to store more cash in the way of PUAs. If a client is easily maxing out their PUAs and wants to prepare to store even more cash, a new policy can do that.
So What’s Happening with the PUA?
The PUA may appear to lose efficiency, but in fact, it does not. It keeps performing as well as it ever did, but the impact lessens because the base premium catches up over time in its efficiency. Therefore, the PUA does not continue to create as much contrast when compared with the efficiency of the base premium.
A very simple metaphor to understand or explain PUAs vs. base premium efficiency might be that of two joggers. If Jogger A gets a 5-minute head start on a marathon, that will put him or her ahead of Jogger B in the first few miles. However, by the time they both reach the finish line, that five-minute head start will seem much more insignificant. If they progress at the same speed, at an “average” marathon pace, their times will be less than 2% apart.
In the same way, the differences between the efficiency of a PUA and the base premium become negligible as time goes on. Like the first jogger, the PUA gets a “head start” while the base premium is responsible for establishing the foundation of the policy (paying for the death benefit, commission, and other policy costs), which slows it down, initially.
Ultimately, the PUA will earn (or “run”) at the same pace in an existing or a new policy. The PUA does not grow less efficient with time, the base premium simply becomes more efficient, which narrows the contrast between the two.
The only way to start a new policy and have the PUA earn at a greater rate and efficiency than in an existing policy would be to begin a new policy on a child or grandchild. When this is done, typically, the new policy is more efficient because the cost of insurance is significantly less for a younger person. Therefore the base premium AND the PUAs will both be pretty efficient. However, as you are limited as to the amount of insurance you can buy on a child—often half of what the parent is insured for, maximum—you will want to make sure that you are adequately insured as well.
You can also find other tutorials and videos at the bottom of our Tutorials page.