Key Takeaways
- Policy comparison should evaluate coverage features, riders, exclusions, premium structure, and flexibility
- A.M. Best, S&P, Moody's, and Fitch are the four major insurance rating agencies, each with different rating scales
- A.M. Best is the specialty rating agency focused specifically on insurance industry financial strength
- Policy illustrations show both guaranteed and non-guaranteed values; focus on guaranteed elements for conservative projections
- The COMDEX score is a composite ranking (1-100) combining ratings from all major agencies
- Policy replacement via 1035 exchange allows tax-free transfers but may trigger surrender charges, new contestability periods, and underwriting requirements
Insurance Policy and Company Selection
Selecting the right insurance policy and insurer is as important as determining the appropriate coverage amount. A policy that meets a client's needs from a financially stable insurer provides peace of mind that claims will be paid when needed. The CFP exam tests your understanding of policy comparison factors, insurer rating systems, policy illustrations, and replacement considerations.
Policy Comparison Factors
When comparing life insurance policies, financial planners must evaluate multiple factors beyond just premium cost. A comprehensive comparison ensures the policy meets the client's current and future needs.
Coverage Features
Death Benefit Options:
| Feature | Description | Considerations |
|---|---|---|
| Level Death Benefit | Fixed amount throughout policy | Predictable, lower cost |
| Increasing Death Benefit | Grows over time (typically with cash value) | Hedge against inflation |
| Flexible Death Benefit | Can be adjusted by policyholder | Universal life policies |
| Return of Premium | Pays back premiums if insured survives term | Higher premium but recovery option |
Premium Structure:
| Type | Characteristics | Best For |
|---|---|---|
| Level Premiums | Same amount for policy duration | Budgeting certainty |
| Graded Premiums | Start low, increase over time | Younger clients, growing income |
| Single Premium | One lump-sum payment | Wealth transfer, estate planning |
| Flexible Premiums | Can vary within limits | Universal life, cash flow flexibility |
Common Life Insurance Riders
Riders are optional policy additions that provide enhanced coverage for additional premium. Evaluate riders based on the client's specific needs and cost-effectiveness.
Most Valuable Riders:
| Rider | Benefit | Premium Impact | Best Candidates |
|---|---|---|---|
| Waiver of Premium | Premiums waived if disabled | Moderate | Working professionals |
| Accelerated Death Benefit | Early access if terminally ill | Often free or low cost | All policyholders |
| Guaranteed Insurability | Purchase more coverage without underwriting | Moderate | Young, healthy clients |
| Long-Term Care Rider | Access death benefit for LTC expenses | Significant | Those without LTC coverage |
| Child Term Rider | Term coverage on children | Low | Parents of young children |
Riders to Evaluate Carefully:
| Rider | Considerations |
|---|---|
| Accidental Death Benefit | May duplicate existing coverage; limited triggers |
| Return of Premium | Significantly higher cost; evaluate opportunity cost |
| Disability Income Rider | Often limited benefits; standalone policies may be better |
Exam Tip: Rider Evaluation
When the CFP exam asks about riders, focus on cost-effectiveness and fit for the client's situation. Accelerated death benefit and waiver of premium are almost always valuable. Return of premium riders require careful cost-benefit analysis.
Policy Exclusions
All life insurance policies contain exclusions that limit coverage in certain circumstances. Common exclusions include:
| Exclusion | Typical Duration | Details |
|---|---|---|
| Suicide Clause | First 2 years | Death by suicide pays only return of premiums |
| Contestability Period | First 2 years | Insurer can contest claims for misrepresentation |
| Material Misrepresentation | Indefinite (fraud) | False statements on application may void coverage |
| War Exclusion | Varies | Death in military combat may be excluded |
| Aviation Exclusion | Varies | Private pilot activities may be excluded |
| Hazardous Activities | Varies | Skydiving, racing, etc. may be excluded |
Policy Flexibility
Evaluate how the policy can adapt to changing circumstances:
- Conversion privileges (term to permanent)
- Premium payment flexibility (for universal life)
- Face amount adjustments
- Loan provisions and interest rates
- Dividend options (for participating policies)
- Surrender options and charges
Insurer Financial Strength Ratings
The financial strength of an insurance company determines its ability to pay claims. Rating agencies evaluate insurers and assign ratings that indicate their financial health and claims-paying ability.
Major Rating Agencies
Four primary agencies rate insurance company financial strength:
| Agency | Focus | History | Key Distinction |
|---|---|---|---|
| A.M. Best | Insurance specialty | Since 1899 | Only agency focused exclusively on insurance |
| S&P Global Ratings | Broad financial markets | Since 1860 | Widely recognized across all industries |
| Moody's Investors Service | Broad financial markets | Since 1909 | Uses unique alphanumeric scale |
| Fitch Ratings | Broad financial markets | Since 1913 | Dual headquarters (NY and London) |
Rating Scale Comparison
Each agency uses a different rating scale, making direct comparisons complex:
| Category | A.M. Best | S&P | Moody's | Fitch |
|---|---|---|---|---|
| Highest | A++ (Superior) | AAA | Aaa | AAA |
| Excellent/High | A+ | AA+, AA, AA- | Aa1, Aa2, Aa3 | AA+, AA, AA- |
| Good/Upper Medium | A, A- | A+, A, A- | A1, A2, A3 | A+, A, A- |
| Fair/Lower Medium | B++, B+ | BBB+, BBB, BBB- | Baa1, Baa2, Baa3 | BBB+, BBB, BBB- |
| Marginal/Non-Investment | B, B- | BB+ and below | Ba1 and below | BB+ and below |
| Weak/Poor | C++, C+, C, C- | B+ to D | B1 to C | B+ to D |
Exam Tip: Rating Scale Differences
An A+ rating means different things from different agencies! A.M. Best's A+ is the second-highest category (excellent), while S&P's A+ is the fifth-highest category. Always identify which agency issued the rating before interpreting it.
Understanding Each Agency's Scale
A.M. Best (Insurance Specialty):
- Uses letter grades with + and - modifiers
- A++ and A+ = Superior; A and A- = Excellent
- B++ and B+ = Good; B and B- = Fair
- Most relevant for insurance-specific analysis
- Ratings below B+ are considered "vulnerable"
S&P Global Ratings:
- Uses AAA through D scale with + and - modifiers
- BBB- and above = Investment grade
- BB+ and below = Speculative grade
- 19 total rating categories
Moody's Investors Service:
- Uses Aaa through C scale with numeric modifiers (1, 2, 3)
- Baa3 and above = Investment grade
- Ba1 and below = Non-investment grade
- 21 total rating categories
Fitch Ratings:
- Uses AAA through D scale with + and - modifiers
- Similar structure to S&P
- 24 total rating categories
Minimum Recommended Ratings
For life insurance purchases, financial planners generally recommend companies with:
| Agency | Minimum Recommended | Category Description |
|---|---|---|
| A.M. Best | A- or higher | Excellent or Superior |
| S&P | A- or higher | Strong or Very Strong |
| Moody's | A3 or higher | Upper Medium Grade or Higher |
| Fitch | A- or higher | Strong or Higher |
COMDEX Score
The COMDEX score provides a composite ranking that combines ratings from all agencies:
- Scale: 1 to 100
- Calculation: Percentile ranking based on all rated companies
- Interpretation: Higher scores indicate better relative standing
- Minimum recommended: 75 or higher
Advantages of COMDEX:
- Simplifies comparison across different rating scales
- Accounts for multiple agency perspectives
- Easy to understand percentile format
Limitations:
- Only includes companies rated by multiple agencies
- May mask important differences between agency assessments
Policy Illustrations
A policy illustration is a projection showing how a life insurance policy is expected to perform under various assumptions. Understanding illustrations is critical for comparing policies and setting realistic expectations.
Components of Policy Illustrations
Basic Illustration Elements:
| Element | Description |
|---|---|
| Premium Outlay | Annual premiums required |
| Death Benefit | Amount payable at death |
| Cash Surrender Value | Amount available if policy surrendered |
| Policy Loans | Available loan amounts and interest rates |
| Dividends | Projected dividend payments (participating policies) |
Guaranteed vs. Non-Guaranteed Values
Every illustration shows two sets of projections:
Guaranteed Values:
- Represent the contractual minimum the insurer must provide
- Based on worst-case assumptions
- Minimum interest crediting rate
- Maximum mortality charges
- Insurance company is legally bound to these values
Non-Guaranteed (Current) Values:
- Projections based on current assumptions
- May be significantly higher than guaranteed values
- Subject to change based on:
- Investment performance
- Mortality experience
- Company expenses
- Not promises or guarantees
| Column Type | Interest Assumption | Mortality Assumption | Use For |
|---|---|---|---|
| Guaranteed | Minimum rate | Maximum charges | Conservative planning |
| Midpoint | Average of guaranteed and current | Average | Reference only |
| Current/Non-Guaranteed | Current crediting rate | Current charges | Optimistic scenario |
Exam Tip: Illustration Analysis
When evaluating illustrations, always focus primarily on guaranteed values. Non-guaranteed projections may never materialize. The midpoint column is NOT the most likely scenario; it's simply a mathematical average. Clients should understand that actual results may fall anywhere between guaranteed and non-guaranteed values.
Red Flags in Illustrations
Watch for these warning signs when reviewing policy illustrations:
| Red Flag | Concern |
|---|---|
| Wide gap between guaranteed and current values | High sensitivity to assumption changes |
| Premiums that "vanish" in early years | Based on non-guaranteed assumptions |
| Cash value projections showing rapid early growth | May not materialize |
| No guaranteed death benefit after certain age | Policy may lapse if underfunded |
| Unrealistic interest rate assumptions | Performance unlikely to match |
Illustration Signature Requirements
Before a policy is issued, both the agent and client must sign the illustration, acknowledging:
- Receipt and review of the complete illustration
- Understanding that non-guaranteed elements may change
- Recognition that actual results may differ from projections
Never sign an illustration without thorough review and understanding.
Policy Replacement Considerations
Replacing an existing life insurance policy requires careful analysis. While replacement may sometimes be appropriate, it can also result in financial harm if not properly evaluated.
When Replacement May Be Appropriate
| Situation | Why Replace |
|---|---|
| Better rates available | Health improved, more competitive market |
| Needed features unavailable | New riders or policy types |
| Insurer financial concerns | Rating downgrades, merger concerns |
| Policy underperforming | Universal life cost increases |
| Changed needs | Different coverage type needed |
1035 Exchange
Section 1035 of the Internal Revenue Code allows tax-free exchanges of life insurance policies:
Permitted Exchanges:
- Life insurance policy to life insurance policy
- Life insurance policy to annuity
- Annuity to annuity
NOT Permitted (Taxable):
- Annuity to life insurance policy
1035 Exchange Requirements:
- Same owner on old and new policies
- Same insured on old and new policies
- Direct transfer between companies (no check to owner)
- Proper documentation and paperwork
Replacement Risks and Costs
Before recommending replacement, evaluate these factors:
| Factor | Consideration |
|---|---|
| Surrender Charges | May reduce available cash value significantly |
| New Contestability Period | 2-year period restarts on new policy |
| New Suicide Clause | 2-year exclusion restarts |
| Underwriting Requirements | Health changes may affect eligibility or pricing |
| Commission Incentives | Agents earn new commissions on replacements |
| Lost Policy Benefits | Older policies may have favorable provisions |
| MEC Status | New policy may become a Modified Endowment Contract |
Outstanding Loan Considerations
If the existing policy has an outstanding loan:
- The loan may create a taxable event during exchange
- Consider paying off loans before replacement
- Evaluate tax implications with a tax professional
Exam Tip: Replacement Suitability
The CFP exam emphasizes that replacement should only occur when clearly in the client's best interest. Red flags include agents pushing replacement primarily for commission purposes, replacement of policies with favorable grandfathered provisions, and exchanges that would create MEC status.
Alternatives to Replacement
Consider these alternatives before replacing a policy:
| Alternative | Description |
|---|---|
| Plan Change | Convert or modify existing policy |
| Supplemental Coverage | Add new policy without replacing |
| Loan Repayment | Restore death benefit by paying loans |
| Paid-Up Options | Use existing value for reduced paid-up coverage |
| Extended Term | Convert to term coverage using cash value |
Summary: Policy and Company Selection
| Factor | Key Considerations |
|---|---|
| Policy Features | Death benefit type, premium structure, flexibility |
| Riders | Waiver of premium, accelerated death benefit most valuable |
| Exclusions | 2-year suicide and contestability clauses standard |
| A.M. Best Ratings | A++ highest; B+ minimum for purchase |
| Rating Comparison | A+ means different things from different agencies |
| COMDEX | Composite score 1-100; prefer 75+ |
| Illustrations | Focus on guaranteed values, not current assumptions |
| Replacement | 1035 exchange is tax-free; evaluate all costs and risks |
A client is comparing insurance companies and sees that Company A has an A.M. Best rating of A+ while Company B has an S&P rating of A+. Which statement is most accurate?
When reviewing a life insurance policy illustration, which values should a financial planner emphasize when setting realistic client expectations?
A client wants to replace an existing whole life policy with a new universal life policy using a Section 1035 exchange. Which of the following is NOT a potential concern with this replacement?