Pacific Life Insurance - NFP · 3. How was Pacific Life able to increase the cap rate from 12% to...

For Producer Use Only. Not For Use With The Public. of 27 MKTG‐OC‐1108

Pacific Life Insurance Company Frequently Asked Questions About Indexed Universal Life Insurance

TABLE OF CONTENTS

THE GROWTH CAP, PARTICIPATION RATE, AND FLOOR RATE Pages 4‐6

1. What accounts for the gap in indexed cap rates from one life insurance product to another? 2. What would cause the current cap rate to decrease? Increase? 3. How was Pacific Life able to increase the cap rate from 12% to 13% for the 1‐Year S&P indexed

account option in February 2011? 4. How can Pacific Life support the current “floor” and “cap” rates? 5. Why do we impose a growth cap for our 1‐Yr and 2‐Yr Indexed Account Options? 6. What does Pacific Life do with the performance above the cap rate? 7. Is the current cap rate locked in when a Segment is created or can that be changed? 8. Can the participation rate be higher than 100%? 9. Why are indexed annuity cap rates lower than indexed life cap rates?

THE INDEXED ACCOUNT OPTIONS: THE ONE‐YEAR S&P 500 ACCOUNT Page 6 10. Why did Pacific Life choose the S&P 500 Index? 11. Is Pacific Life investing in stocks for this product? 12. Why aren’t dividends included?

THE INTERNATIONAL INDEXED ACCOUNT OPTION Pages 7‐11 13. Why did you finally bring an International option to market and why are the caps for the indexes

the same as they are for the 1‐Yr S&P option? 14. Why did you choose 3 indexes for the International option? Why not 4, or 5 and why not other

indexes? 15. Are the 3 international indexes set in stone, or could Pacific Life replace any or all of them with

other global indexes? 16. How exactly do the weightings work with the International option? Are the caps applied first, or

the weightings? Can you walk through an example of how the indexed interest credit actually works?

17. How are we hedging for the 3 international indexes, and how is that hedging strategy similar or different to the strategy we employ currently with our S&P indexed options?

18. Are the weightings for the international indexes locked in stone, or could Pacific Life change the weightings from the 1/3‐1/3‐1/3?

19. While they are each at 13 percent currently, can the current cap rates differ among the three indexes that comprise the International option?

20. I like the ING Global product, where the best of the 3 indexes enjoys a higher weighting than the worse‐performing indexes. Why didn’t you guys go with that kind of model?

21. How do currency exchange rates affect the performance of the International indexed account option?

22. Will the current cap rates for both the S&P and the International Option move together, or will they potentially move separately?

23. Given the relatively short histories of the international indexes, how confident can we be in the historical average rates of return provided by the IUL Rate Calculator?

24. How can I track the International option in my local paper?


THE TWO‐YEAR S&P INDEXED ACCOUNT OPTION Pages 11‐12 25. How do the historical returns for the 2‐Yr S&P compare with the 1‐Yr S&P? 26. Is the 2‐Yr S&P’s cap rate potentially more volatile than the 1‐Yr S&P? In other words, will the 2‐

Yr cap tend to fluctuate more frequently than the 1‐Yr, or is the 1‐Yr more volatile? 27. Can you get out at the 1‐Yr point of the 2‐Yr S&P option? 28. If the S&P increases 30% in Yr 1 but then drops 20% in the second year, what’s my indexed return

for the 2‐Yr indexed account? 29. AXA has a 3‐Yr S&P indexed account; why did Pacific Life choose 2 years instead of 3 years?

THE HIGH‐PAR FIVE‐YEAR ACCOUNT Pages 12‐14 30. Why did you retire the 5‐Year Indexed Account? 31. How will this decision (retiring the 5‐Yr indexed account) impact inforce clients who have current

segments in the 5‐Yr indexed account? 32. How does “five‐year‐point‐to‐final‐year‐average” work? 33. Why did we average the 5th Year instead of going with a “true” point‐to‐point for the 5‐Year

Accounts? 34. How can you offer 115% current participation for the High‐Par 5‐Year Account? 35. Can new indexed account options be added to inforce policies?

ILLUSTRATING INDEXED UL Pages 14‐16 36. What are the default and maximum illustrated crediting rates for your indexed account options

and why? 37. Does Pacific Life have a recommended allocation for clients between the 4 indexed options and

the fixed account? 38. What is a reasonable expectation for long‐term interest rates on an IUL product compared to

Universal Life (UL) and Variable Universal Life (VUL) products in similar interest rate/market environments?

39. How do returns on investments tied to the indexes including dividends compare to the returns for an indexed UL product?

40. Some IUL products include guaranteed persistency credits. Doesn’t this give them an inherent advantage over similar products without bonuses?

HEDGING Pages 16‐18 41. From whom does Pacific Life buy their hedges? 42. What happens if a hedge provider goes out of business? 43. What is meant by “dynamic hedging”? 44. How does the hedging process actually work? 45. Will adding the new indexed account options “water down” Pacific Life’s ability to get good

pricing for hedges on the 1‐Yr S&P? TRANSFERS, POLICY LOANS AND WITHDRAWALS Page 18‐19

46. Can a client transfer indexed Segment values in the middle of a Segment term? 47. Can a client withdraw/borrow values from a specific Segment? 48. Can a client withdraw/borrow values and receive partial indexed credit? 49. What is the “lockout” provision and why was it implemented?


THE ALTERNATE LOAN RIDER (ALR) Pages 19‐266 50. Pacific Life has criticized the variable rate loan concept as long as you’ve been selling indexed UL.

Why the sudden change of heart, and how should we see the introduction of your Alternate Loan Rider (hereafter “ALR”) as anything other than a cynical “if you can’t beat ‘em, join ‘em” ploy?

51. How can you prevent the abuses and excesses you mention once you make a similar loan option available to your independent producers?

52. Why don’t you allow ALR in the first 3 policy years? 53. Why don’t you allow ALR in conjunction with the 2‐Yr and/or High‐Par Five indexed account(s)? 54. How much impact will a client see from the leverage in an ALR? 55. Why isn’t the loan rate fixed and guaranteed at 5.75% for the life of the contract? Other

companies guarantee a low fixed rate for the life of the policy. 56. What was Pacific Life’s guiding philosophy in developing the ALR? 57. Is Pacific Life profit‐neutral to the ALR? In other words, does Pacific Life experience a financial

windfall when the S&P® tanks; i.e., they collect 5.75% from the client and don’t have to pay them any offsetting interest in a negative year for the S&P?

58. How can Pacific Life afford to pay indexed interest on money that has been loaned out? 59. How do you determine the loan interest charged? What will make this go up or down? 60. Can the loan interest rate increase after I take a loan? Can it go down? Can I switch to a

standard loan anytime? 61. What is the maximum loan I can take? Why? 62. Can I illustrate how my ALR would have performed in the past? 63. Can I illustrate the risks involved in the ALR? 64. Can the ALR cause my policy to lapse? 65. What provisions are in place to stop someone from taking ALR loans when the market is up and

converting them to standard loans when the market is down? 66. Can I add the ALR to an existing PIA III contract? 67. Why isn’t the ALR loan rate tied to an external index like Moody’s? 68. When might I want to convert my ALR to a standard loan? 69. What is the big deal about Pacific Life (PL) allowing policyowners to have both ALR and Standard

Loans outstanding?


Pacific Life Insurance Company Frequently Asked Questions About Indexed Universal Life Insurance THE GROWTH CAP, PARTICIPATION RATE, AND FLOOR RATE1E 1. What accounts for the gap in indexed cap rates from one life insurance product to another?

A company looking to establish a presence in the indexed universal life (IUL) market can make an immediate impact if they appear to offer a higher cap/par/floor rate than the average competitor. In addition to company discretion, there are 2 main factors that influence the cap: (1) Interest Yields on the bonds used to back the product, and (2) Options Prices. In order to offer a higher cap, a company could do any of the following: • Invest in riskier, and hence higher‐yielding bonds • Employ “dynamic hedging2” where the index options are not “perfectly” hedged • Build in extra insurance loads/charges to cover the hedging costs • Accept lower profits (or spend company surplus) in order to establish market share In any case, additional risk is being introduced to the indexing strategy that may result in the company lowering the cap rate as soon as any of these additional risks begin to materialize. Products with higher initial cap rates may end up having below average cap rates, leaving the clients stuck with a sub‐par product that initially appeared to be ahead of the pack.

2. What would cause the current cap rate to decrease? Increase?

Our cap rate depends on 2 major factors: (1) the anticipated yield on our general account assets, and (2) the price of the call options in the derivatives market. If either the yield fell and/or the options price rose, the company would potentially need to lower cap rates. If on the other hand yields increased and/or options prices decreased, a company might be able to increase the cap rate.

3. How was Pacific Life able to increase the cap rate from 12% to 13% for the 1‐Year S&P indexed account option in February 2011?

We have been able to restructure our hedge packages that we purchase. This new structure has efficiencies that effectively lower our cost. We have passed on this lower cost by increasing the cap. We feel that this increase is sustainable for the foreseeable future.

1 Throughout the document, Growth Cap will be referred to as “cap,” Participation Rate as “par” and Floor Rate as “floor.” 2 For a specific discussion of dynamic hedging, see question 43 below.


4. How can Pacific Life support the current “floor” and “cap” rates?

Within an IUL product, the assets that we purchase to back our client’s indexed Segments are not invested in the indexes directly. The client’s accumulated values are invested in our general account, which consists of mostly fixed‐income securities. The investment income earned on the portion of assets allocated to the index accounts are used to purchase a package of call options on an index, such as the S&P 500. The call options we purchase are specifically designed to match the Segment’s index growth rate, guaranteed interest rate, growth cap and participation rate. By hedging the indexed accounts in this manner, Pacific Life does not lose money if returns are below the floor, but it also does not make money if returns are above the cap.

5. Why do we impose a growth cap for our 1‐Yr and 2‐Yr Indexed Account Options?

Since neither Pacific Life nor the clients actually purchase the stocks in the indexes, nobody has the right to full participation in the movement of the indexes. The limits, or caps, on how much the client can enjoy are set based on the cost of the options Pacific Life purchases from investment banks. We use the anticipated yield on our fixed account portfolio to purchase these hedges. The hedge providers (the investment banks) construct hedges that effectively set a top and bottom limit to the index return over either a 12 or 24 month index segment term.

6. What does Pacific Life do with the performance above the cap rate?

When we purchase the hedges from the investment banks, the upper limits (caps) are set at the time of purchase. The hedge provider effectively buys a call option on the index and then sells a call option on the same index with a strike price equal to today’s price plus whatever the cap rate is. If and when the index delivers returns above the cap, the bank will collect the full return of the index—but then have to pay that portion of the performance above the cap rate to the party to whom it sold the option. Pacific Life has no direct participation in any index performance above the cap.

7. Is the current cap rate locked in when a Segment is created or can that be changed?

The current cap rate is locked in for the duration of the Segment. We can change the cap rate anytime for new segments or reinvested Segments after their maturity.

8. Can the participation rate be higher than 100%?

Yes. If bond yields rise and/or index option prices fall, a company could afford to increase either the cap rate or the participation rate. In fact, we did raise the current participation rate for the High‐Par 5 Option in February 2011 from 110% to 115%. At no time, however, could our participation rate fall below 100% (or 105% on the High‐Par 5 Option).


9. Why are indexed annuity cap rates lower than indexed life cap rates?

While both life and annuity products purchase index options from the same “window,” the investments used to back the general account of an annuity contract tend to need more liquidity, and hence lower yields result. These lower yields tend to prevent annuity products from having the ability to purchase cap options with rates as high as a comparable indexed life product.

THE INDEXED ACCOUNT OPTIONS: THE ONE‐YEAR S&P 500 ACCOUNT

10. Why did Pacific Life choose the S&P 500 Index?

The Dow Jones Industrial Average, the Standard & Poor’s 500 (S&P 500), and the NASDAQ are probably the most recognized measures of the U.S. stock market. These are the indices you see quoted on the news every night. Of these, the S&P 500 represents the broadest measure of the overall US stock market. Over 70% of all index options available in the IUL marketplace are directly tied to the S&P 500.3 Furthermore, the market for call options on the S&P 500 is broad, liquid and relatively stable compared to other less broadly diversified indices. This enables us to offer more competitive cap and par rates than if we use a smaller, more volatile index, since the price of call options is influenced by expected future index volatility.

11. Is Pacific Life investing in stocks for this product?

No. We are purchasing hedges from investment banks on the indexes. These hedges give Pacific Life the ability to pass indexed gains along to the client without assuming the investment risks of a stock investment.

12. Why aren’t dividends included?

Since we do not purchase the stocks of the indexes, we do not receive dividends. A company could theoretically tie index performance to the total return of the index(es), which includes dividends. However this is not as recognized and widely used. More importantly, the cost of options purchased on an index that reflects dividends would be more expensive, which may translate into a lower growth cap.

3 AnnuitySpecs Quarterly Report for Indexed Life, 4th Quarter 2010


THE INTERNATIONAL INDEXED ACCOUNT OPTION 13. Why did you finally bring an International option to market and why are the caps for

the indexes the same as they are for the 1‐Yr S&P option? In February 2011, Pacific Life introduced a 1‐Yr International indexed account4 option comprised of the Hang Seng5, Euro STOXX 506, and MSCI Emerging Markets7 indexes. We’ve always been committed to keeping the product as simple as possible. We’ve resisted the temptation (to which some other companies have fallen) to add a myriad of indexed account options to the point at which the product begins to resemble a variable universal life product. We started with a 1‐Yr indexed account and after 2 years, added our 5‐Yr indexed account. In 2011 we restructured our S&P‐linked options and added a 1‐Yr International indexed account option8. The international indexes we’ve chosen have similar volatility to the S&P, resulting in hedging prices that are similar to the price for the hedge on the S&P. We also benefit from the fact that like our 1‐Yr S&P option, our hedge takes both a bearish and bullish position on the indexes, further reducing the hedge’s volatility. While we can’t guarantee that this will always be the case, we are happy to introduce the International option with the same constituent current cap rates as the 1‐Yr S&P option—13 percent.

4 Known in the contract as the 1‐Year Indexed Account 2 5 Hang Seng Indexes Company Limited ("HSIL") and Hang Seng Data Services Limited ("HSDS") have licensed Pacific Life Insurance Company to use the Hang Seng Index in connection with this life insurance product. This product and its 1‐Year International Indexed Account are not sponsored, endorsed, sold or promoted by HSIL or HSDS. HSIL and HSDS make no representation regarding the advisability of purchasing a life insurance product. Please read the disclaimer in relation to the Hang Seng Index in the policy illustration. For more information about the Hang Seng Index, please visit www.hsi.com.hk. 6 The EURO STOXX 50® is the intellectual property (including registered trademarks) of STOXX Limited, Zurich, Switzerlandand/or its licensors (“Licensors”), which is used under license. The Product that includes the Index is in no way sponsored, endorsed, sold or promoted by STOXX and its Licensors and neither of the Licensors shall have any liability with respect thereto. 7 The Product and its 1‐Year International Indexed Account referred to herein is not sponsored, endorsed, or promoted by MSCI, and MSCI bears no liability with respect to any such Product and any included index. The Policy Contract contains a more detailed description of the limited relationship MSCI has with Pacific Life Insurance Company and any related Product. 8 Referred to as the 1 Year Indexed Account 2 in the Contract


14. Why did you choose 3 indexes for the International option? Why not 4, or 5 and why not other indexes?

We wanted to select indexes that (a) had the potential to outperform US‐based indexes, (b) had a measurable history that would translate to meaningful illustrated rates, (c) gave producers and clients a marketable story without unnecessary complexity or cost, and (d) had sufficient liquidity so the index could be hedged at a reasonable cost. There was already precedent in the marketplace for a 3‐index design (AIG/American General, Western Reserve, and ING). We’ve always wanted to keep our indexing story as simple as possible, but a single index approach just didn’t have quite the global reach of a 3‐index approach. Keeping the weighting simple allows us to introduce an international option that we feel is much easier to explain than the other 3‐index models in the market. Our method also allows us to offer 100% guaranteed participation on a 1‐Yr point to point basis, which the other multi‐index models cannot currently match.

15. Are the 3 international indexes set in stone, or could Pacific Life replace any or all of them with other global indexes?

We could replace any or all of them, but don’t have plans to do so. If we had to make changes, we would likely maintain as best as we could the broad global footprint we’ve established at rollout. We expended considerable energy in researching other potential indexes and are very happy with the three we’ve chosen. We believe the "global" footprint story we've established with this new indexed account option is a move in the right direction.

16. How exactly do the weightings work with the International option? Are the caps applied first, or the weightings? Can you walk through an example of how the indexed interest credit actually works?

Each of the 3 indexes is measured on a point to point basis and currently limited to a 13% growth cap rate. No individual index will produce individual pre‐weighted returns of more than 13% or less than 0% per year. The three returns are then averaged and that number becomes the effective indexed interest credit for the segment.


Here’s a simple example, based on the 12‐month time period between December 15, 2009 and December 15, 2010: Index Index

Return 100% Par Rate

Apply Cap & Floor

Average the 3 Returns

Segment Indexed Credit

Hang Seng

+5.3% +5.3% +5.3% +5.3 +0.0 +13.0 +18.3

+18.3 ÷3 +6.1

+6.1% Euro STOXX

‐1.6% ‐1.6% +0.0%

MSCI EM

+15.2 +15.2 +13.0%

17. How are we hedging for the 3 international indexes, and how is that hedging strategy

similar or different to the strategy we employ currently with our S&P indexed options?

We can change our hedging strategy at any time. However, our current hedging strategy is very similar to the strategy we employ for the S&P 1‐Yr indexed account. The notable exception is that we only buy one‐third of each of the three indexes for any given segment. For example, if we had $1 Million of new premiums that needed hedging in our 1‐Yr S&P indexed account, we’d purchase a hedge based on a notional $1 Million invested in the S&P 500. But for the 1‐Yr International indexed account, we’d purchase 3 hedges based on $333,333 notional in each of the Hang Seng, Euro STOXX 50 and MSCI Emerging Markets. We could have asked a hedge provider to create a “combined” index option that would automatically weight the 3 indexes but that would have created an extra cost that might have resulted in a lower growth cap rate. By purchasing the index options separately, we achieve the same desired result for less cost—and potentially higher current growth caps. For more on hedging, see questions 41‐45.

18. Are the weightings for the international indexes locked in stone, or could Pacific Life change the weightings from the 1/3‐1/3‐1/3?

We consciously avoided varying the weightings between the indexes (as many competitors have done) because those variations could create the impression that we have a preference for or possess unique insights about the future performance of a particular index. We also wanted to keep the math simple—and equal weighting of the 3 is as simple as you can get.


19. While they are each at 13 percent currently, can the current cap rates differ among the three indexes that comprise the International option?

No. We designed the product so that the same cap applies to all three of the indexes that comprise the international option. Allowing the caps to vary by index would create complexity but not add much value. We chose to keep the product simple where possible.

20. I like the ING Global product, where the best of the 3 indexes enjoys a higher weighting than the worse‐performing indexes. Why didn’t you guys go with that kind of model?

The ING model—while it produces attractive historical rates of return—is a relatively expensive model to hedge, since the seller of the hedge is always on the hook for a larger return on the higher‐performing indexes. This increased cost is borne by the client by the 5‐Yr timetable (instead of 1‐Yr for ours) and a current 65% participation rate (instead of 115% currently for us). Our decision to go with a fixed‐weighted model also reflects our conviction that indexes are more likely to move together as opposed to the less correlated patterns of the somewhat distant past. The ING model inherently depends on at least one of the three indexes to hit the proverbial “home run” every 5 years. The dollars the company spent on the 2 “underperforming” indexes are in large part “wasted.” If, however, all 3 indexes performed similarly, our method will provide indexed credits for all 3 indexes—and 100% participation—essentially giving the client what they “paid” for.

21. How do currency exchange rates affect the performance of the International indexed account option?

We both hedge and credit interest for the international option in US dollars. There is no additional cost for currency risk.

22. Will the current cap rates for both the S&P and the International Option move together, or will they potentially move separately?

Despite the fact that they are equal today, the caps can move in independent directions, depending on the relative volatility between the domestic and international equity markets. We chose the three international indexes in large part because together they currently carry similar volatility to the S&P. The fact that our hedge takes both long and short positions in the 1‐Yr indexed options can potentially offset the relative volatility of individual indexes.


23. Given the relatively short histories of the international indexes, how confident can we be in the historical average rates of return provided by the IUL Rate Calculator?9

It is indeed important to recognize that the international indexes don’t enjoy the long measurable track record of the S&P. The Hang Seng, Euro STOXX 50 and MSCI Emerging Markets only track back to 1969, 1987 and 1988, respectively. As far as the IUL Historical Rate Calculator, we’d encourage producers and clients to focus on the 90% and 75% confidence factors in addition to considering the averages produced by the calculator. We feel that it is always good business practice to use the calculator to demonstrate a range of historical outcomes, and erring on the side of being too conservative seems prudent to us. For more on the calculator and our illustrated rates, see Question 36 below.

24. How can I track the International option in my local paper?

The ticker symbols for the 3 indexes are HSI (Hang Seng), SX5E (Euro STOXX), and MXEF (MSCI Emerging Markets). Given the lack of detailed index listings in most daily newspapers your best bet would probably the internet. Just punch the ticker symbols into a search engine such as Bloomberg.com and you should be able to easily track an index’s progress.

THE TWO‐YEAR S&P INDEXED ACCOUNT OPTION 25. How do the historical returns for the 2‐Yr S&P compare with the 1‐Yr S&P?

Using returns through 2010, the 2‐Yr S&P is about 80 basis points higher based on a 40‐Yr historical look‐back, assuming current cap and par rates and assuming that the person holds the money for 20 years. For a table, see Question 36 below.

9 In Pennsylvania, the 1‐Yr indexed accounts will have a 12% current cap, the 2‐Yr cap will be 28%, and the 5‐Year Indexed Account will remain at 100% participation with no current growth cap. The default illustrated rates will be 7.5% for the 1‐Yr S&P, 7.25% for the International, 8.25% for the 2‐Yr and 9.00% for the Five‐Year. Maximum rates will be 8.00%, 7.75%, 8.75% and 9.50% respectively. Historical returns are no guarantee of future performance. Pacific Indexed Accumulator was not offered for sale until September 2005, so the returns shown are not representative of actual product performance. The actual historical growth cap of this product, had it been available, over the period analyzed might have been higher or lower than assumed, and likely would have fluctuated with market conditions, subject to product guarantees.


26. Is the 2‐Yr S&P’s cap rate potentially more volatile than the 1‐Yr S&P? In other words, will the 2‐Yr cap tend to fluctuate more frequently than the 1‐Yr, or is the 1‐Yr more volatile?

The cap rates are driven by the hedge cost of the indexed account. We don’t have enough history to know what the difference will be in hedge cost volatility between a 1‐Yr indexed account and a 2‐Yr indexed account. In theory the longer the indexed account term, the more volatile the hedge cost could be. However, we take a long‐term approach to matching hedge cost to indexed accounts and so far have effectively absorbed the hedge cost volatility to provide stable caps on all of our indexed accounts. Competitors such as Aviva have offered a 2‐Yr indexed account alongside a 1‐Yr indexed account and have tended to move the caps in lockstep.

27. Can you get out at the 1‐Yr point of the 2‐Yr S&P option?

You are definitely making a 24‐month commitment when you allocate monies into the 2‐Yr indexed account. No accounting—or escape option—occurs at the 12 month mark. Just like any of our indexed accounts, you can withdraw or borrow funds anytime but those distributions will only receive pro‐rata indexed credits at the end of the segment period—and you’ll be locked out of allocating any new premiums or fixed account balances to any indexed account for 12 months. For more on transfers, see questions 48‐51.

28. If the S&P increases 30% in Yr 1 but then drops 20% in the second year, what’s my indexed return for the 2‐Yr indexed account?

No accounting takes place at the end of the first year for the 2‐Yr indexed account. All that matters is the S&P’s closing price on the segment start date and the segment ending date 24 months later. The percentage change between those 2 numbers becomes the basis of the indexed interest credit.

29. AXA has a 3‐Yr S&P indexed account; why did Pacific Life choose 2 years instead of 3 years?

While a 3‐Yr S&P indexed account would have produced a higher potential cap rate, we didn’t think that the extra year of waiting added enough to the cap to justify the wait. AXA is the only company with a 3‐Yr S&P option; Aviva has sold a 2‐Yr S&P option for many years and it has provided an attractive option for clients. For clients who want a higher cap, we offer the 5‐Yr High‐Par indexed account, which has no current cap at all. AXA doesn’t offer anything like the High‐Par.


THE HIGH‐PAR FIVE‐YEAR ACCOUNT 30. Why did you retire the 5‐Year Indexed Account?

After we introduced the High‐Par 5 indexed account back in August 2009, we’ve seen a growing preference from clients for the High‐Par 5‐Yr over the “standard” 5‐Yr indexed account. One 5‐Yr indexed account instead of two just seems to make sense from a “keep it simple” perspective. Concentrating all our 5‐Yr monies into one indexed account instead of two also potentially increases our volume and ability to achieve more competitive pricing for the High‐Par 5 option hedges. In Pennsylvania, where the High Par 5‐Year Indexed Account is not available, we will continue to provide the 5‐Year Indexed Account so that policyowners there can also have 3 durations of S&P 500 Indexed crediting as will be available elsewhere.

31. How will this decision (retiring the 5‐Yr indexed account) impact inforce clients who have current segments in the 5‐Yr indexed account?

Conditions that were current as of the day their segments were established will not change—100% participation, 1% annual floor, and no growth cap. Once these segments mature, however, clients will not be able to renew into another 5‐Yr indexed account; they’ll need to let us know whether they’d like to reallocate to the 1‐Yr S&P or 1‐Yr International, the 2‐Yr S&P, or the High‐Par Five. Unless they tell us otherwise, we’ll move monies into the fixed account.

32. How does “five‐year‐point‐to‐final‐year‐average” work?

In contrast to a pure 5‐year‐point‐to‐point measurement, which would compare the index’s closing price on the identical trading day five years apart, the point‐to‐final‐year‐average simply uses the index’s average closing price over the last 12 months of the 5‐year Segment period as the final “point.” The index’s starting point is still the S&P’s closing price on day one of the 5‐year period. The final point is the average closing price for the 14th of the month (or next trading day if the market is closed) over the last 12 months of the 5‐year period. The percentage change between those two points is calculated and credited to the client’s indexed account value for that Segment, subject to par rates, growth caps and floors.


33. Why did we average the 5th Year instead of going with a “true” point‐to‐point for the 5‐Year Accounts?

Averaging reduces the risk to the client when a severe correction at the end of the 5th year could wipe out gains over the entire period. For example, a 5‐Yr Segment begun on December 15, 2003 measured on a strict point‐to‐point basis would have shown the index down ‐18.68%. On the other hand, averaging the final 12 months of the Segment would have shown an increase of 12.81%. It should be noted that averaging does potentially reduce some gains in a rising market, but we felt that the reduction in volatility more than offsets the potential gain.

34. How can you offer 115% current participation for the High‐Par 5‐Year Account?

Investment banks are able to put together hedge packages that do exactly that—currently guarantee a 5‐year return on the 5‐Year Point‐to‐Final‐Year‐Average with a current participation rate of 115 percent.

35. Can new indexed account options be added to inforce policies?

Pacific Indexed Accumulator III (PIAIII),10 Indexed Pacific Estate Preserver (IPEP),11 M’s Versatile Product Indexed UL Survivorship (MVP IUL‐S)12 and M’s Versatile Product Indexed UL (MVP Indexed UL)13 contracts contain language that allows us to offer the new indexed accounts to these clients. Unfortunately, that language is not included in the Pacific Indexed Accumulator (PIA)14 and Pacific Indexed Accumulator II (PIAII)15 contracts, and as such, the new indexed account options are not available to those clients. However, the higher cap rates for the 1‐Yr S&P indexed account will apply for all PIA inforce policies since we first rolled out this product in 2005. Some companies have released new products with higher 1‐Yr S&P cap rates than available on the inforce product. With our 1‐Yr S&P indexed account, the same par, cap and floor rates apply for PIA (I), PIA II and PIA III equally—further evidence that at Pacific Life, we treat existing policyholders as well as new ones. We may also be the first company to make new indexes available to inforce clients.

10 Policy Form No. P08PI3 11 Policy Form No. P09IEP 12 Policy Form No. P09IEM 13 Policy Form No. P08PIM 14 Policy Form No. P05PIA. No longer available for new sales. 15 Policy Form No. P05PIA No longer available for new sales.


ILLUSTRATING INDEXED UL

36. What are the default and maximum illustrated crediting rates for your indexed account options and why?

Most companies set their illustrated interest rates to equal the average rates of return (based on any number of calculation methods) over a historical period—generally 20 years or more. In the past we’ve used a default rate that is close to an average rate of return for 40 years and then set a maximum rate 50 basis points above that. With the release of our 2 new options we are setting our maximum illustrated rates more conservatively: Historical Return16 Default Rate Maximum Rate1‐Yr S&P 8.01% 7.75% 8.25% 2‐Yr S&P 8.82% 8.50% 9.00% 5‐Yr High‐Par S&P 10.12% 9.50% 10.00% 1‐Yr International 7.41% 7.50% 8.00%

37. Does Pacific Life have a recommended allocation for clients between the 4 indexed

options and the fixed account?

Indexed UL is currently not a registered product. Producers will want to explain the differences between the various options but to constantly remind the client that at the end of the day, it’s not necessarily what the index does but rather how well the insurance company manages its investing and hedging strategy to deliver competitive par and cap rates for the inforce client. With our February 1 changes, however, we now have an expanded range of indexed account options that can be structured to take advantage of a client’s risk/reward profile, time horizon, and/or liquidity needs. For the client with a long time horizon and higher tolerance for liquidity risk, we have the High‐Par 5 indexed account option. For clients at the other end of the spectrum—approaching retirement and starting to access funds—we have the fixed account. For clients in between, we have 1‐Yr S&P and International options and a 2‐Yr S&P. Our Navigator software allows you to design illustrations that vary allocations over time, giving clients a potentially more realistic expectation of returns given their particular circumstances.

16 The average of each 20‐yr accumulation period in the past 40 years; The average of each 10‐yr accumulation period in the past 22 years for the International option. Source data from Bloomberg as of December 31, 2010; averages based on Pacific Life Insurance Company’s IUL Historical Rate Calculator.


It may also be well worth considering allocating a portion of your clients’ policy value to the fixed account to help offset the impact of policy charges in early years.

38. What is a reasonable expectation for long‐term interest rates on an IUL product compared to

Universal Life (UL) and Variable Universal Life (VUL) products in similar interest rate/market environments?

It’s difficult to make predictions, especially given the short history of indexed UL products. Many factors will influence how these 3 product types will react to varying financial conditions. In general, clients taking on greater investment risk over the long‐term should expect higher overall returns. On average, interest rates on an indexed UL product will tend to be modestly higher than a traditional UL product, given the lower guaranteed rates for IUL products versus UL products. In theory, VUL products should produce yields that are higher than IUL over the long‐term, reflecting the risk that is being assumed by the client. But there have been, and certainly will be periods where these risk/return relationships will not hold to these patterns.

39. How do returns on investments tied to the indexes including dividends compare to the returns

for an indexed UL product?

It’s generally not appropriate to make these kinds of comparisons, given the significant differences between the types of products in question. However, just in terms of what impact the dividend component of the S&P 500 has had on historical rates of return, dividends have increased the S&P’s annual return by anywhere from 1% to 4% since 1990.

40. Some IUL products include guaranteed persistency credits. Doesn’t this give them an inherent

advantage over similar products without bonuses?

Just because a company is obligated to honor a contractually guaranteed persistency credit does not prevent that same company from changing non‐guaranteed policy features to balance the ultimate costs of maintaining a policy. A company that felt the need to include a guaranteed persistency credit might find it difficult to financially afford the credit without reducing expenses in another area, such as lowering the non‐guaranteed current cap rate. If this happens, the client may find himself/herself with a product that paid a bonus, but is now tied to a cap rate that is well below another product’s cap rate that didn’t include a bonus.

HEDGING

41. From whom does Pacific Life buy their hedges?

Pacific Life buys our hedges from large investment banks. We don’t concentrate our purchases in any particular bank, just as we don’t concentrate our other investments in


any one company, sector, or industry. We continually perform due diligence on our options providers to ensure that our counterparty risk is minimized.

42. What happens if a hedge provider goes out of business?

From the client’s perspective, nothing unusual happens. Pacific Life has the contractual obligation to honor the cap, floor and par rates in the client’s policy, no matter what happens to the option seller. This is precisely why it is important for Pacific Life to completely hedge our indexed account options, and to purchase our hedges from well diversified, financially secure institutions. If one of those institutions were to fail, Pacific Life would have to cover the contractual obligations from our company reserves and surplus. We are well‐capitalized to do so, should that unlikely event occur.

43. What is meant by “dynamic hedging”?

Dynamic Hedging is a method companies use to replicate the returns on the call options by purchasing a mixture of fixed and equity securities. A company that dynamically hedges its IUL products is taking some additional investment risk that the hedge may not work perfectly and instead take on the risk of having to cover any shortfall out of their company surplus. Pacific Life currently is not using a dynamic hedging method for its IUL product portfolio, in order to perfectly match the returns promised the owner by purchasing call options. This additional risk may allow a company to offer cap/par/floor rates that are more favorable than the rates that are offered by companies who employ “perfect” hedging. From a client’s perspective, these types of hedging strategies introduce the risk that the company might entice the client to buy a product because of a high cap/par/floor rate, only to subsequently drop those rates.

44. How does the hedging process actually work?

Just like any UL product, IUL premiums are assessed a sales load and then are invested in Pacific Life’s general account for that product. The premiums stay there for the duration of the indexed Segment. But on the side, Pacific Life purchases a hedge option to support the indexing strategy. How does that work? Let’s walk through a simple example. If the client has requested that 100% of their premium go into our 1‐Yr indexed account, we need to purchase a hedge for that net premium. We contact an investment banker and ask for a quote for a package of options that would cover a 0% floor and 13% cap on the S&P 500 for 12 months. That banker will give us a price quote as a percent of the net premium—say, 5%. That means for every $1000 of net premium to be hedged, we’d have to pay the investment banker $50. That $50 needs to be “paid for” by the interest we earn on the client’s net premium in our general account. As long as we can earn 5 percent ($50) over the 12 months on the $1000 we invested in the general account, we can afford the 13% cap hedge. The client’s premiums remain in the general account; only the anticipated


earnings on that premium inside the general account are in play for the hedging transaction. At the end of the 12 months, the option contract matures and we pass through the return to the client. If the S&P 500 finishes in negative territory, the option expires and the hedge pays nothing. However, if the index is up for the year, the option pays us the S&P 500 return up to the 13% cap. That return is applied to the client’s net premium (based on the average balance over the 12 months) as an interest credit.

45. Will adding new indexed account options “water down” Pacific Life’s ability to get good pricing for hedges on the 1‐Yr S&P?

We hear this question often—frequently in the context of the whole industry; i.e., if IUL explodes in popularity, are there enough hedge options to go around, so to speak? On any given day, billions of dollars in S&P options are traded in the futures markets, and that volume is expected to continue to increase. We actually benefit by the expansion of the market, as it makes more options and providers available for purchase to create IUL accounts. The more real risk is the insurance company’s ability to manage investments and hedging strategies internally. This will have a direct impact on a company’s ability to deliver a competitive cap rate—not the lack of indexed options available for purchase at market.

TRANSFERS, POLICY LOANS AND WITHDRAWALS

46. Can a client transfer indexed Segment values in the middle of a Segment term?

No. Clients can take withdrawals and loans anytime but they cannot transfer monies from an indexed Segment to a new Segment or the fixed account until the end of each Segment’s term. Lockout rules would apply if the distribution is not part of a systematic distribution plan.

47. Can a client withdraw/borrow values from a specific Segment?

No. All monthly policy charges, policy loans, and withdrawals will be deducted from the Fixed Account until it is exhausted. If the deduction exceeds the amount available in the Fixed Account, then the balance of the deduction will be taken next from the 1‐Year Indexed Account, then the 1‐Year International Indexed Account, then the 2‐Year Indexed Account, and finally from the High Par 5‐Year Indexed Account (or 5‐Year Indexed Account, if in PA). Within each Index Account, the deduction is made pro rata across all Segments in that Account.


48. Can a client withdraw/borrow values and receive partial indexed credit?

Yes. Deductions taken from the Indexed Accounts reduce the Segment Monthly Balance to which the Indexed Interest Rate is applied. Effectively, the policyowner will receive a partial indexed credit on the amount of the deduction, based on the amount of time that the money was in the Indexed Account. Some competitors do not provide this benefit.

49. What is the “lockout” provision and why was it implemented?

If a client takes an unplanned distribution (withdrawal or policy loan) a 12‐month lockout period will apply. This means that the client is prohibited from allocating any new premiums to an indexed Segment for one year after the unplanned distribution. It does not restrict maturing Segments from being reallocated, nor does it apply to scheduled distributions through our Automated Income Option. For most clients, this should not be a concern as they are unlikely to be paying in new premiums at the same time as taking distributions from the policy.

THE ALTERNATE LOAN RIDER (ALR)17

50. Pacific Life has criticized the variable rate loan18 concept as long as you’ve been selling indexed UL. Why the sudden change of heart, and how should we see the introduction of your Alternate Loan Rider (hereafter “ALR”) as anything other than a cynical “if you can’t beat ‘em, join ‘em” ploy?

Pacific Life has certainly taken a negative stance towards the use of variable rate loans to inflate illustrated income distributions for indexed universal life (IUL) products. If you take a look, however, at any of our printed material on the subject, our criticism has more to do with what we see as the potential abuses of the variable rate loan in illustrations. We routinely see illustrations that show clients that with very little out of pocket cost, they can generate tax‐free19 income streams and net death benefits that could solve the national debt crisis.

17 Form No. R10ALR. Riders will likely incur additional charges and are subject to availability, restrictions and limitations. Clients should be shown policy illustrations with and without riders to help show the rider’s impact on the policy’s values. 18 Throughout this article, the expression “variable rate loan” is used to include any loan provision that creates the opportunity for positive arbitrage by crediting loaned funds the same rate as unloaned funds. These loan programs are also known as “indexed” or “participating” loans. 19 Tax‐free income assumes, among other things: (1) withdrawals do not exceed tax basis (generally, premiums paid less prior withdrawals); (2) policy remains in force until death; (3) withdrawals taken during the first 15 policy years do not occur at the time of, or during the two years prior to, any reduction in benefits; and (4) the policy does not become a modified endowment contract. See IRC §§ 7702(f)(7)(B), 7702A. Any policy withdrawals, loans and loan interest will reduce policy values and may reduce benefits.


In our opinion, we feel that for most clients, a standard20 loan may be the best fit for accessing funds at retirement. However, the simple reality is that we did not want to restrict access to a loan option that is almost universally accepted in the IUL marketplace, and potentially attractive to clients who understand and accept the potential risks of using leverage during the distribution phase of the policy’s life. Our concern, however, is that we generally feel that in many cases clients don’t fully understand or appreciate the potential risks involved in a variable rate loan structure, and companies utilize the eye‐popping numbers to, in large part, draw a client’s attention away from and minimize the value of other, more important considerations such as financial stability, cap rate history and inforce policyowner treatment—the proverbial focusing on the “sizzle” and not really talking about the “steak.” In our decision to bring a version of one of these loan options to the market, we did so with the understanding that we do NOT want the ALR to give any client the impression that they can use leverage to buy “free” insurance.

51. How can you prevent the abuses and excesses you mention once you make a similar loan

option available to your independent producers?

Few, if any, of the carriers who promote variable rate loans spend much time explaining it in print or in more forthcoming numerical demonstrations. We plan to discuss it in writing, often and in some detail. We believe that our producers, if well informed, are in the best position to decide along with their clients if the ALR is an appropriate option. We will also implement some restrictions on the ALR’s use, such as restricting its use to Policy Years 4+.

52. Why don’t you allow ALR in the first 3 policy years?

In our opinion, one of the most abusive illustrations we’ve seen suggests to a potential client that they need only commit to making one premium payment in Year 1 and then proceed to borrow premiums in each successive funding year, using the illustrated arbitrage to create the impression that you can generate large income amounts and death benefits with very little out of pocket cost. Like a zero or limited‐down payment mortgage, these types of scenarios can create the potential for an almost certain lapse when the leverage fails to support the illustrated values and the client is notified that he/she will need to pay further out‐of‐pocket premiums to keep the policy in force. While limiting the ALR to policy years 4+ does not completely eliminate the potential for this type of abuse, we felt it was an important first step in reminding producers and clients that the ALR is not a ticket to “free insurance.” It is an alternative borrowing method that should only be used if the client fully understands the potential risks—and at the same time, actually needs the life insurance and is prepared to fully fund the contract with true out‐of‐pocket premium payments.

20 Throughout the article, “standard” loan refers to a traditional policy loan where both the charged and credited rates are set by the company at a fixed level.


53. Why don’t you allow ALR in conjunction with the 2‐Yr and/or High‐Par Five indexed account(s)?

The structure of the multi‐year accounts simply does not work well with the ALR. Insurance contract charges continue to eat away at the account value during the intervening years, and even though the client is protected from negative equity index returns, the ALR charges after a protracted down period could add more stress to a loaned policy than desired.

54. How much impact will a client see from the leverage in an ALR?

The maximum illustrated leverage will be 2.25% (5.75% charged rate, 8% maximum credited rate). Of course, the actual leverage may be higher, given our current cap of 12 percent. The client will see a range of improvement to their illustrated distributions, depending on the assumptions. We have seen similar improvement ratios with other companies’ illustrations when you set their arbitrage at similar levels. It appears, however, that there is an exponential benefit from increased arbitrage from some competitors’ illustrations. For example, one company’s income more than doubled when the arbitrage was increased from 2.25% to 3.25%.

55. Why isn’t the loan rate fixed and guaranteed at 5.75% for the life of the contract? Other

companies guarantee a low fixed rate for the life of the policy.

Before a client becomes fixated on one particular policy feature of any life insurance policy, a producer would be well‐advised to remind them that a life insurance policy has many other moving parts, many of which are subject to change by the carrier. Just because a company has a low guaranteed cost of borrowing does not prevent that company from looking elsewhere—such as the cap rate or cost of insurance rates—should a product become less profitable than originally anticipated—especially if a particular feature within the product might be the direct cause for the potentially undesirable results that could be experienced by the carrier. Companies typically set their charged rate for these types of loans at the yield they would need to earn on their invested assets to purchase their current indexed option. The risk that a company assumes in setting that rate is that the price of the option increases to a point at which their charged rate won’t cover the cost of the index hedge. Pacific Life set the maximum loan rate for our ALR with what we felt was a comfortable safety margin. If interest rates were to rise along with the cost of index options, we would have the ability to increase our charged rate to as high as 7.5%.

56. What was Pacific Life’s guiding philosophy in developing the ALR?

We certainly didn’t introduce the ALR so that we can suddenly super‐charge our life insurance retirement strategy (LIRS) illustrations. Like anything we do at Pacific Life, we want our products to perform well for the client over the long haul. In bringing the ALR to PIA III, we didn’t want this decision to do anything that would unnecessarily


jeopardize those PIA III clients who choose NOT to take the ALR when they begin distributions. There were essentially four basic loan models that were considered:21

1. Double Variable, Loan Rate Uncapped: Offered by Minnesota Life, this loan program lets both the charged and credited rates float. The charged rate is tied to the Moody’s index and has no limit as to how high it could go. The credited rate is tied to the indexing strategy chosen, and is limited by the cap and floor associated with the option.

2. Double Variable, Loan Rate Capped: Typified by Aviva and similar to #1, the main difference here is that unlike the Minnesota version, the company places an upper limit on how high the charged rate for the loan can go.

3. Single Variable, Loan Rate Fixed: Made popular by Penn Mutual and Allianz, the single variable loan charges a flat rate for the loan. This rate is guaranteed by the company and can never change. The credited rate works just like #1 and #2 above, and would be subject to current floors and caps.

4. Single Variable, Loan Rate Fixed and Capped: PIA III takes this route. Similar to #3, the fixed rate is set and declared at a current rate (currently 5.75%) that is subject to a potentially higher rate under the contract (up to a maximum loan rate of 7.50%). It is important to also note that the decision to adjust the ALR loan rate is at Pacific Life’s discretion and is not tied to any outside index (e.g., Moody’s).

While #1 and #2 tend to provide the most illustrated arbitrage (because current Moody’s rates are at all‐time lows), they do carry the very real potential risk that Moody’s rates could rise to high levels and erase any potential arbitrage opportunities. #2 does provide some upside limit but that rate tends to be high (9.5% for Aviva), increasing the pressure on the indexing strategy to deliver high rates of return to achieve arbitrage. #3 has been popular with producers because of the relatively low fixed rate for the loans—5% for Lincoln and 6% for Penn and Allianz. We considered doing the same thing but felt very uncomfortable that by doing so we might be subjecting our new and inforce customers to greater hedge pricing sensitivity that could put undesired pressure on product growth cap rates. The fixed charged rate for a participating loan is set by a company based on how much that company anticipates paying for the index hedge. If hedge prices increase, a company taking option #3 doesn’t have the contractual ability to increase that charged rate. They may feel pressure to lower the cap rate which impacts every policyholder—whether or not they have taken out a variable rate loan.

21 Many life insurance products have some flexibility in how they are structured. For example, death benefit coverage under certain products may be provided through a combination of the base policy and any available term or other riders. Each policy selected, illustrated, and sold should be structured based upon your client’s particular insurance needs and financial objectives. It is your responsibility to know that the particular policy selected, illustrated, and sold will best meet your client’s needs and objectives both now and in the future.


We adopted the position that a potentially more “responsible” approach was to marry the best elements of #2 and #3—charge a relatively low fixed rate for the ALR and reserve the right to increase the charge for the loan if hedge costs increase. This means that we could pass along the higher cost directly to only the clients who chose to use ALR.

57. Is Pacific Life profit‐neutral to the ALR? In other words, does Pacific Life experience a financial windfall when the S&P® tanks; i.e., they collect 5.75% from the client and don’t have to pay them any offsetting interest in a negative year for the S&P?

With the ALR it is important to understand that loaned and unloaned accumulation values are treated equally with regards to the indexed interest credit. In other words, Pacific Life doesn’t buy a separate indexed hedge for each ALR that a client takes. The rate that we will charge for the ALR is intended to approximate the rate of return from the portfolio supporting the product. The only potential profit/loss for the indexing strategy is the spread between that earned/charged rate and the rate we pay for the index hedge. So whether the S&P turns in a positive return or a negative return, we are still only “out” the difference between the price we paid for the hedge and what we earned on our general account / charged for the ALR. It’s the client that receives the windfall if the S&P is up.

58. How can Pacific Life afford to pay indexed interest on money that has been loaned out?

When a client asks for an ALR, Pacific Life sells a part of its general account portfolio of bonds to make the loan to the client. All of the client’s account value—loaned and unloaned—remains invested in the product’s general account portfolio. In order to replace Pacific Life’s potential loss in interest income on the bonds we sold to fund the loan, Pacific Life sets up a loan account for the ALR client with a currently‐charged rate of 5.75%. This essentially creates an asset that bears an annual rate of return for Pacific Life that replaces the interest lost on the bond sale. The client thus assumes the risk that if the S&P returns do not exceed this 5.75% (or whatever is the current) charged rate, that loan balance may grow faster than the client would have seen if a standard loan had been taken instead. This is the essential value proposition of the ALR loan—it requires the client to assume the arbitrage risk of the 1‐Yr indexed account’s performance versus the current rate charged for the ALR.

59. How do you determine the loan interest charged? What will make this go up or down?

The loan charged rate is set relative to the cost of a 1‐Yr hedge on the S&P 500 with a current cap of 12 percent. Currently, 5.75% is enough to cover that cost. If the cost of the hedges were to rise (generally due to rising interest rates and/or increased stock market volatility), Pacific Life may have to consider increasing that charged rate, but never more than 7.50%.


60. Can the loan interest rate increase after the client takes a loan? Can it go down? Can the client switch to a standard loan anytime?

Each loan under the ALR will be added to the ALR balance when taken, and interest is charged based on the policy’s anniversary date. The rate—as noted above—is set to approximate what Pacific Life pays for the index hedge. The current loan ALR rate can be changed by Pacific Life on each policy anniversary. The client does retain the right to switch to a standard loan—but only once per policy year.

61. What is the maximum loan the client can take? Why?

Because the ALR accrues interest charges on a daily basis—but the segment indexed interest credit doesn’t occur until the end of a segment term—we want to make sure that a client never takes out so much money that the policy is in immediate danger of lapse. With the ALR, that danger is increased since the spread between the charged rate and credited rate is not guaranteed and fixed. As such, we will determine a “maximum allowable loan” amount that you cannot exceed at any given time with the ALR—equal to the value of the 1 year indexed account, less policy charges and policy loan interest to the end of the policy year (and, of course, less debt). See the contract for details.

62. Can the client illustrate how the ALR would have performed in the past?

Clients should certainly consider the impact of varying interest rate scenarios on an ALR loan. The Navigator illustration system will provide a supplemental report that will show how your illustration values are impacted by applying historical rates of return. Our IUL Historical Rate calculator can assist you in determining what interest rates might be reasonable to your client, based on actual history (historical returns are no guarantee of future performance). The illustration software will also allow the client to test different charged‐rate scenarios for the ALR, which can provide further perspective on the relative risks/rewards of the ALR loan. We believe our capability to portray and demonstrate the ALR under varying economic scenarios—historically based or via assumed rate scenarios—is a major marketing benefit to better ensure seller and buyer understanding of how the ALR works and in better setting “appropriate expectations.”

63. Can the client illustrate the risks involved in the ALR?

You are certainly welcome in the Navigator software to choose a loan rate of up to the maximum of 7.5% and a credited rate of the 0% minimum to show the impact of a worst‐case scenario. You can also request a historical supplement to the illustration that will show the client the impact of a 20‐ or 40‐Yr history on the illustrated values. Clients should be clearly informed about the risks they assume with the ALR. If they hesitate in the slightest, it’s probably best to direct them to the standard loan, where the worst‐case‐scenario spread is just 0.25%, all years.


64. Can the ALR cause the client’s policy to lapse?

If the client is carrying a large ALR loan and the premium payments and/or interest credits aren’t enough to offset the policy’s charges, then yes—the ALR could play a role in the lapse of the policy. The ALR by itself won’t cause a lapse, but the client needs to be very clear as to the increased risk potential posed by the ALR. A standard loan locks in a very low‐cost rate of borrowing for the life of the policy where stability and predictability is most valued by the client. The ALR, on the other hand, unlocks the low rate associated with a standard loan and can charge up to 7.5% on the full balance of the loan in a year when the indexed interest credit is zero. This loan rate “tradeoff” would be in exchange for the potential of greater long‐term indexed return associated with the ALR structure.

65. What provisions are in place to stop someone from taking ALR loans when the market is up and converting them to standard loans when the market is down?

Many people assume that they will be able to time the markets but in reality nobody will really know with certainty when is the right time to switch from an ALR loan to a standard loan or vice versa. This is a matter of the risk/reward tradeoff that each owner must decide. What is important for clients to know is that with the ALR they always have the flexibility to switch from an ALR to a standard loan—even during a policy year (unlike some competitors) and without first paying off any existing loan balance from outside funds like some other products. Further, we allow a client to carry both ALR and standard loans simultaneously, giving a client more flexibility to tailor the loans to an overall risk profile. This last point, we believe, is unique to the industry currently.

66. Can the client add the ALR to an existing PIA III contract?

No. Only newly issued PIA III policies will be able to have the ALR as an option.

67. Why isn’t the ALR loan rate tied to an external index like Moody’s?

Many carriers allow the charged rate to float along with an outside index like the Moody’s rate. This gives the company considerable protection against a rise in the level of interest rates and index hedge prices. But historically, the Moody’s rate has been as high as 12 percent as recently as the late 1980s. For the client, positive arbitrage could be very difficult to achieve consistently when you are paying 12 percent for a loan. We decided to take a middle route on this issue. We charge a current fixed rate of 5.75 percent for the ALR, but we reserve the right to raise that rate to a maximum of 7.5 percent. While in today’s environment an ALR loan rate of 5.75 percent can support a 12 percent cap, in a rising interest rate environment that same 5.75 rate might not support a 12 percent cap. If a large number of clients have chosen the ALR and we were limited to an ALR charged rate that didn’t support the current cap, we might be facing the situation where we’d have to lower the cap for everybody, whether or not they had ALR loans outstanding.


68. When might the client want to convert the ALR to a standard loan?

Nobody has a crystal ball, and those types of decisions will always be made based on a guess about the future. Generally speaking, the ALR carries more risk/reward than does the standard loan. That typically means that when the client’s risk tolerance decreases, they may want to consider transferring loaned monies from the ALR to the standard loan. But again—these decisions we believe are best left to clients and producers. As a carrier we just want to do everything we can to explain the relative risks of each loan option and encourage you to make decisions based on all the facts.

69. What is the big deal about Pacific Life (PL) allowing policyowners to have both ALR and Standard Loans outstanding?

No other company that we know of currently provides policyowners this flexibility. With Pacific Life, the client doesn’t have to bet everything on one strategy—they can layer their loans between standard and ALR to spread out their exposure and risk. Some IUL carriers require the policyowner to pay off the existing loan balance in cash before they can transfer the loan balance from the variable to the standard loan option. Even if the company doesn’t require this payoff before a transfer occurs, they still limit the client to all or nothing—either all variable loans or all standard loans.

This material is not intended to be used, nor can it be used by any taxpayer, for the purpose of avoiding U.S. federal, state or local tax penalties. This material is written to support the promotion or marketing of the transaction(s) or matter(s) addressed by this material. Pacific Life Insurance Company, its distributors and their respective representatives do not provide tax, accounting or legal advice. Any taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor. Pacific Life Insurance Company is licensed to issue individual life insurance and annuity products in all states except New York. Product availability and features may vary by state. Product and rider guarantees are backed by the financial strength and claims‐paying ability of Pacific Life. Pacific Life Insurance Company's individual life insurance products are marketed exclusively through independent third‐party producers, which may include bank affiliated entities. “S&P 500®”, “Standard & Poor’s 500” and “S&P ®” is a trademark of Standard & Poor’s Financial Services LLC and have been licensed for use by Pacific Life Insurance Company. The life insurance product is not sponsored, endorsed, sold or promoted by Standard & Poor's, and Standard & Poor's makes no representation regarding the advisability of purchasing a life insurance product. For more information regarding the criteria for index additions and removals, please visit www.standardpoors.com. The Index is unmanaged and not available for direct investment, and does not include the reinvestment of dividends. Non‐guaranteed elements are not guaranteed by definition. As such, Pacific Life Insurance Company reserves the right to change or modify any non‐guaranteed element. This right to change non‐guaranteed elements is not limited to a specific time or reason. The products discussed in this presentation do not directly participate in any stock or equity investments. Failure to maintain the policy to maturity may result in no participation in the equity index. Competitor information presented based on data received directly from the company.

Pacific Life Insurance Division Address: 45 Enterprise, Aliso Viejo CA 92656

(800) 800‐7681 Lifeline.PacificLife.com

Investment and Insurance Products: Not a Deposit – Not FDIC Insured – Not Insured by any Federal Government Agency – No Bank Guarantee – May Lose Value


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