The Visible Policy
Page 5, BBAG It!

In the BBAG

There is a problem with modeling dissimilar things.  Permanent insurance does not act like a T+I strategy.  And there are only seven people in the whole world who know the full details about how my policy acts.  I am not one of those seven.  So how do I compare when there are so many unknowns?  One way is formalization of ignorance.  Ignore what you don't know, compare what you do.  Black Box Annual Gain is one answer:

All that needs to be known to calculate BBAG concerning virtually any sort of investment is the value at the beginning of year (value_boy), the value at the end of the year (value_eoy), any out-of-pocket cash during the year (deposits), and any in-to-pocket cash during the year (withdrawals).  Here is the formula:

value_eoy - value_boy - deposits + withdrawals
-----------------------------------------------
value_boy + deposits - withdrawals

I do not model any withdrawals; it is stated simply for completeness.
Taxes are not BAGG'd as a withdrawal -- they do not yield in-to-pocket cash.
(... not your pocket, anyway ;)

For monthly payments, the denominator would be:
value_boy + (deposits - withdrawals)/2

Something amazing is revealed.  Even though you may know very little about what is "inside the box", following the BBOX curve gives you an almost psychic view of certain details.

Why are there so many bumps in all the curves?  In mathematical terms, BBAG results in a "differentiated" function.  Hmmm, let's try that again.  BBAG is like a sneeze.

"AAAHH!!"   {neck and shoulders thrown back}
"CHOOOOO!!!"   {head, neck, and torso plunge forward}

Or, I could just say, "1.2 liters of air was expelled strongly from your lungs."  Both are accurate ways of describing the same event; the "differentiated" description supplies a lot more drama.  What drama do the curves reveal?  Here, let's see some secrets.

• The solid purple and turquoise lines in the middle are the T+I cases.

up to age 48 -- very bumpy!
The total return on the underlying bond fund (VBIIX) from 1996 to 2001 (beginning when I was 42) varies.  It's return is affected by both bond income and the underlying relative value of the bonds themselves.  In the long run gain is steady, but year-to-year there are significant changes in Net Asset Value of the fund.  Bumps.
up to age 71 -- smooth ascension
Those years haven't happened yet.  I assume an annualized yield of 6.75% for every year, so no bumps.  The curves slowly strive to reach that point, being held back by the \$485/year term insurance premium.  The "min T+I" curve is held back more because \$485 is a higher percentage of it — less total money invested than "max T+I", so \$485 has a greater effect on "min".  Still, both ascend because total value in both is increasing, and the term cost is remaining constant.
up to age 73 and 74 -- essentially flat
Term premiums stop; earnings match the 6.75% assumed annualized yield.  Well, kind of.  At about age 71, the law requires that money begins coming out of IRA's.  So, a 20-year period begins of the investment moving from VBIIX into an unspecified tax-free municipal bond fund.  I assume an annualized yield of 6.25% on it.
up to age 91 -- slow minor downward drift
Two things are happening.  First, the total yield is slowly dropping from 6.75% to 6.25% as funds are transferred out of the IRA.  Second, the money transferred out of the IRA is subject to a one-time tax.  (I assume a tax bracket of 15%.  Only the funds actually transferred each year are taxed.  Funds still within the IRA still accrue tax-deferred.  Once funds are within the tax-free fund, they are not subject to income tax again — not even when passed to heirs!  Thus this money can act just like a death benefit on life insurance.
up to age 99 -- constant
You see the 6.25% yield assumed on the tax-free municipal bond fund.  No more taxes; no more transfers.

All the other earnings curves conspired to hide the taxation.
Fortunately, there is very little that can be hidden from a BBAG curve.  You won't necessarily know what happened, but it will be obvious if something did.

Ok, these are not secrets.  All details are known ahead of time -- the T+I models are my creation, after all.  How about the real black box, a "Whole Life" insurance policy?

• The other three lines (brown, orange, and green) are Total Cash Value.
My model tracks three insurance strategies, "base policy", "base policy with extra payments past year 12" (XP), and "front-loaded OPP".  Just like the two T+I cases, these three curves seem to have the same general personality, and track each other.  And, boy, do they bounce!

(Note that the XP and Base cases are exactly the same for the first 12 years; XP simply continues normal premium payments a bit longer.  OPP uses extra money above premium to "overfund" the policy.  While this occurs, BBAG is dragged down due to a larger denominator.  Once premiums and overfunding cease in all three cases, the ratios are on an equivalent footing.)

 Since the tables below comes directly from the spreadsheet, I used the same style conventions. bold column labels are beginning-of-year values. non-bold labels are end-of-year, or somewhere in between yellow background is a value which is either historical or guaranteed To date, I have received statements for the first five policy years.  These numbers are not projections, guesses, or derived calculations.  They are what NYL has actually reported to me, or guaranteed in the policy contract. Dark Yellow represents a mixture of guaranteed and speculative. I have not yet made the OPP payments for the final three years shown, so increasing the guaranteed value by this amount is neither historical nor guaranteed. violet background is a value directly from the policy illustration white background (normal) is a value derived by my model

Let's use one of Ricky's dictums to see what's causing the bouncing:

bbag_curve + numbers = intuited_grey_box
-- Ricky's Little Book of Financial Truisms

I suggest you open up the BBAG curve (click on it to get a 2nd, smaller window of just the image), then scroll back down here.  You may be able to look at the curves, the tables, and my description at the same time.

 Base Policy Yr valuebeg.of year premium (cash_oop) deltaGuar.Value estimatedCosts valueend of year bbag comments 1 \$0 \$1764 \$0 -\$1764 \$0 -100% Compare BBAG with dGV (change in Guaranteed Value). Oscillations in dGV are the primary reason BBAG seems so bouncy. This remains true for the life of the policy. Other sources of earnings build rather smoothly, but dGV goes up and down for no obvious reason. The Estimated costs column involves a lot of guesswork and supposition. Don't trust it except to get an approximate idea of what policy fees might be. The model does not use estCost as input into any other calculation. 2 \$0 \$1764 {\$3528} \$0 -\$1604 \$160 -91% 3 \$160 \$1764 {\$5292} \$1300 -\$304 \$1,673 -13% 4 \$1,673 \$1764 {\$7056} \$1600 {\$2900} -\$304 \$3,548 3.2% 5 \$3,548 \$1764 {\$8820} \$1500 {\$4400} -\$404 \$5,390 1.5% 6 \$5,390 \$1764 {\$10,584} \$1800 {\$6200} -\$304 \$7,603 6.3% 7 \$7,603 \$1764 {\$12,348} \$1800 {\$8000} -\$304 \$9,892 5.6% 8 \$9,892 \$1764 {\$14,112} \$1800 {\$9800} -\$304 \$12,265 5.2% 9 \$12,265 \$1764 {\$15,876} \$1900 {\$11,700} -\$304 \$14,828 5.7%

• The continued bumpiness is due to oscillations in Guaranteed Cash Value.
I blame a lot of the localized variance on some marketing manager years ago.  Let's call him Manager Mayfield.  A conversation like the following may have taken place in the mid-1950's:

MM:  Yes?  Oh, it's you.  Enter.
[young clerk enters Manager Mayfield's office and stands nervously]
MM:  Your Guaranteed Cash Value table is very precise.
clerk:  Thank you, sir.  [clearly pleased]
MM:  I don't want precise.
clerk:  Sir?!?
MM:  People want hundreds, they don't want dollars.
clerk:  I do not understand, sir.
MM:  The numbers are too ... busy.  Why say \$1327?  \$1300 is better.
clerk:  \$1327 is the right number, sir.  Well, \$1326.89 was right, but I rounded.
MM:  Round some more.  No, don't round.  Just make the last two numbers '0'.
MM:  Add it in the next year.  Give me two zeros each year.  Hundreds.
MM:  ... People like hundreds.  I like hundreds.
clerk:  Well, ok.  ... but ... it will make our job messier.
MM:  [stares at clerk]
clerk:  Yes, sir.  Good day, sir.  [exits stage right]

I more or less understand why NYL chooses to list Guaranteed Cash Value in divisions of hundreds.  (I like hundreds, too!)  But since GCV is a primary component of policy earnings, the arbitrary \$100 increments do show up in a plot.  Hence, continuos bumps are observed in Black Box Annual Gain.

For comparison, the below table adds in front-loaded extra payments, and completely messes up Manager Mayfield's marketing simplifications.

• OPP tracks higher than XP, which tracks higher than the Base Policy case.
Dividend rates are pretty much the same in all three curves.  Guaranteed Cash Value is the same in all three curves.  They vary because of a third and even fourth source of annual gain, called LIV (Linear Increase in Value).  OPP has a lot more LIV than XP, which has a little more than the Base Policy case.

• The dip in later years is likely due to cost of insurance.
Remember, Fred the actuary says I'm supposed to be dead at 79.  The cost of insurance gets really expensive as I approach this age, and downright astronomical once I pass it.  So why does the curve flatten out and go positive again?  Remember the earlier curves that shows the convergence of Total Cash Value and Death Benefit?  There was a reason to cause this convergence.  It was not done just because it "seemed natural" or "looks good".  My policy only insures the difference between Base Death Benefit and Guaranteed Cash Value.  This is all it needs to do.  Besides, if it kept paying for a flat \$100,000 Death Benefit, the cost of insurance would likely eat up all earnings.  So the lines converge, and the amount that needs to be insured gets less.  Cost of insurance remains manageable, even though expensive.

BBAG is useful if you only care about annual, not total performance.  In fact, no matter how "psychic" the information provided, the above curve is useless in representing total performance.  (Differentiation:  all plot, no theme.)

Accesses since 31 May 2001
© 2001 - 2010 by Rich Franzen
New model incorporated August 2002.

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 No content within The Visible Policy has been approved, authorized, or verified by New York Life or any of its representatives.  I have attempted to fairly and accurately portray the policy, but there are likely to be mistakes.  Over time, I shall endeavor to correct any misinformation found herein.