Universal Life and Lifetime Guarantees
By Chris W. Kite, MBA, Vice President-Strategic Relations, COSS

Roger Blease noted that premiums for lifetime-guarantee ULs dropped a remarkable 4.8% in the second half of 2004 despite regulatory uncertainties and reinsurance tightening. A drop of 8.5% for female premiums was even more remarkable. These drops are driven by market competition and perhaps by expectations of higher interest rates.

Depending on your viewpoint, lifetime-guarantee ULs are attractive, innovative, and/or aggressive. Critics say the providers are betting on higher interest rates, questionable lapse rates, and continued favorable mortality. They seem to agree that reserve rules should eventually be updated, but that it is better, safer, and fairer to have some redundancy and a formula or some other method to set manageable regulatory limits. Those favoring ALIA’s approach say that these products have been properly tested against a wide range of scenarios. They respond to market demand for low cost life insurance.

For news about a second draft of AG38 and the ongoing debate to be addressed at the June NAIC meetings, Visit this link. Will the solvency issue be debated or are minds set with the focus now on political jockeying for position?

For the level-playing field issue, a key question is whether products with similar guarantees should require similar reserves. Should the lifetime-guarantee ULs have similar reserves to whole life or traditional UL? Or are they not so similar? When agents and consumers look at lifetime-guarantee ULs do they understand and accept the trade-offs or do they just see the low premium for the face amount? They should be able to easily see that these low premiums do not guarantee substantial cash value. They should also understand the importance of maintaining the premium payment and any catch-up provisions. Should they be advised that these products are less likely to participate in interest rate increases or other improvements due to the long-term pricing assumptions?

The Evolution of Life Insurance Products
Lifetime-guarantee UL is a new species of life insurance. When LIMRA or other associations survey life insurance ownership, they have the dilemma of how to categorize UL due to its flexibility. Is it term or perm? Typically it is put in the perm (permanent) category, but UL is often used with low premium options that are term-oriented. Even the term market has evolved where over half of term products have a level premium for 20 or more years as opposed to the annual renewable or 5-year term plans that used to be dominant. Lifetime-guarantee UL and term trends show a market movement toward long-term protection at low premiums. These trends reflect budget limits, desires for guarantees, and the tax advantage of a death benefit.

In its surveys, LIMRA has not found a practical way to gather actual policy data to see if a policy is “permanent”. Gathering data on cash values, actual premiums paid, paid-up additions, etc. is hard to do. Instead their approach has been to ask the policyholder their intent. Was the policy intended to be permanent? A UL policy would be put into a term category if the policyholder did not intend it to be permanent. A study would have to be done to see how well premium payments and policy management matched intentions.

LIMRA reports that the lifetime-guarantee UL market has been focused around issue ages 55 to 60. At these ages, the policies provide a few years of traditional income protection, but are focused toward a longer-term benefit. They also have the ability to be accumulation oriented if higher premiums are paid, but that use is not typical. If the policyholder intended to pay a higher premium, different products are probably more appropriate for combining protection and accumulation. I put the lifetime-guarantee UL products in a legacy category. People like the simplicity of two numbers. You pay a relatively low premium and guarantee a death benefit. As long as you pay the premium, you leave a legacy.

This design answers the problem of a policy becoming a gamble. In the strictest sense, only a paid-up policy is permanent. From my experience with regulations and policy dynamics, I tend to say “cash value life insurance” rather than “permanent life insurance” for other combinations. In a traditional UL, you should keep the cash value from decreasing in order for it to be considered permanent. Otherwise, it becomes a gamble on whether the policy will last as long as you do. Lifetime-guarantee ULs shift the risk from the policyholder to the company. It is great that these UL designs take away the gamble for the individual, but have the companies and reinsurers taken on too much risk as a whole?

UL was designed as an interest-sensitive product with a flexible premium. It also has an adjustable benefit, but typically companies have not provided an automated way to manage the policy and adjust the benefit. As I addressed the gamble problem in the 1990’s, I recommended use of option 2 UL with a plan to reduce the face amount near retirement if the policyholder did not elect to fund the benefit. This use of UL would be like having a guaranteed insurability option to age 100. It allows for higher guideline premiums, greater accumulation, and avoids the inefficiency of “buy high, sell low” in variable life with a level death benefit. A segment of the market uses UL in a similar way for accumulation goals. The market has also responded to these issues by providing combinations of term and cash value products. Term riders can drop off when the policy takes a transition from protection to accumulation goals. For companies who choose not to offer a competitive lifetime-guarantee UL, combinations of term and perm would seem to be the best alternative.

Lifetime-guarantee UL pricing at issue depends on long-term expectations for interest rates, but these products are far from being as interest sensitive as traditional UL once issued. They are far less likely to participate in interest changes, up or down. The dynamics are reversed. Decreasing the interest rate would lower cash value, but effectively lower the policyholder cost for the death benefit net of cash value since the no-lapse premium or shadow account factors do not change. Lower cash value may actually increase persistency since the far greater benefit is for holding the policy until death. Canada with term to age 100 experienced about a 1% lapse rate. The US market may not go that low, but the cash value of these products may be low enough to be comparable to term to age 100.

How would an increase in interest rates affect the overall demand for lifetime-guarantee ULs? How would the demand be affected by a gradual increase versus a short-term spike? At the April Life Insurance Conference, Milliman noted the expectation that these products would remain the focal point as long as rates do not rise more than 200 to 300 basis points. That may be true, but these products are different enough that the low premiums, guarantees, and simplicity to agent and consumer could still be very attractive. Premiums for lifetime-guarantee ULs could go down further to the extent the interest rate increase is viewed as a long-term trend.

Variable Life and Equity Indexed Combinations
Roger Blease notes that his surveys include four hybrid products where the base policy is a lifetime-guarantee UL with a low premium. Additional premiums can be paid into variable accounts. These amounts added to both the cash value and the death benefit.
Roger’s surveys include equity-indexed ULs that have lifetime guarantee premiums. The surveys show these premiums as well as accumulation if a higher premium is selected. The equity index products tend to illustrate at 200 to 300 higher basis points so that have the flexibility of illustrating competitive products for both the legacy and the accumulation markets.

Life Settlements and Premium Financing
The reverse dynamics of these products may lead to interesting long-term use of life settlement and premium financing concepts. The life settlement market should become more efficient at evaluating policies that are worth substantially more than their cash value. This added value develops in lifetime-guarantee UL even when life expectancy is not reduced. Companies with aging blocks of lifetime-guaranteed ULs may need to defend against life settlements by offering their own. They could encourage surrender by offering a higher cash value that would cost less than carrying the death benefit. The policyholder’s preference for a legacy versus a need for cash value may change.
We could also see “ma and pa” premium financing concepts. The policyholder may be willing to pay a higher loan rate to keep the death benefit guarantee and discontinue out-of-pocket premiums. The loan would be paid out the death benefit. The insurance company or a third party could provide this financing. It avoids the risk of missing a premium payment and losing the death benefit. Even with catch-up provisions, I can see risks to missing payments as insureds age and family or others take over management of payments.

Graphs and Analysis of Current Market
Contact me at chrisk@cossdev.com if you would like the presentation that I used in the May 17th Market Connection. I used a similar presentation the week before at LISSSG (Life Insurance Sales Support Study Group). It includes graphs of data from Roger Blease’s surveys. I have also revived my credit-cost disclosure analysis from the 1990’s. Over about 10 years, illustrated interest rates have dropped about 200 basis points. Guaranteed interest rates have dropped about 100 basis points. These drops seem to have been more than countered by reductions in costs via preferred classes or lifetime guarantees. Good news for consumers as long as the companies do not run into solvency risks.

Please send me your comments, questions, and suggestions.