Cost of Life Insurance Increases
By Gary Bottoms, CLU, CHFC
During the 1980s, the combination of relatively high interest rates and emerging technology allowed for flexibility in the design of life insurance policies. However, flexibility requires management and ongoing attention. Just paying the planned premium is not necessarily enough to keep the coverage healthy. Unless they are prompted, consumers are unlikely to review their policies on their own and consider changes so the policy will serve its intended purpose. In recent years, the speed of change has been accelerating. This article is intended to help TBG’s clients and friends better understand a recent development that may have an impact upon their existing life insurance coverage. In short, policy reviews are essential. TBG is ready to help.
Recently, a small number of life insurance carriers announced that they’re increasing their cost of insurance (COI) rates charged on blocks of in-force universal life (UL) policies. This move has prompted concern in the industry about its impact on in-force policies, while raising questions about why carriers have taken this action. The best way to address these questions is to start with an understanding of COI rates and what could prompt a carrier to make changes to those rates.
What is COI?
The largest single cost factor of life insurance contracts is the COI charged over the life of the policy. In pricing products, insurance carriers make assumptions about many factors, including interest rates, infrastructure costs, profit margins, policy lapses, mortality of the particular product line, aggressiveness in market share acquisition and market segment focus. The combination of these factors determines both the current and maximum (guaranteed) COI rates. When carriers file UL contracts for state approval, the filing includes both the current and maximum COI rates that the carrier can implement. Maximum COI rates provide the insurance carrier flexibility in the policy’s charges if their initial pricing assumptions don’t hold for the duration of the policy.
What factors can change pricing assumptions?
The most obvious pressures on life insurance carriers’ pricing assumptions are the persistently low interest rate environment and a 30-year decline in portfolio yields. Those two factors together suggest that on many policies, the carriers didn’t experience the assumed interest rate spread they were initially priced to receive. Additionally, some of those under-performing policies have higher minimum guaranteed interest crediting rates than today’s economic environment can support. This leaves carriers with little to no spread between what their assets earn and what they have to credit to the policies under the guarantees.
An additional cause of carrier pressure results from adverse mortality experience. Interestingly, adverse mortality experience doesn’t just come from older-age mortality; it often comes from term conversions by unhealthy policyholders. In carrier parlance, this is known as “policyholder anti-selection,” and it results in an increasing number of unprofitable policies, which adds pressure to the carrier’s pricing assumptions. The effects of anti-selection are compounded when profitable policies are replaced by coverage from other carriers. As profitable policies that insure healthy individuals move off the carrier’s books to a new carrier, the original carrier is left with a further deterioration of its mortality experience on the remaining block of policies.
Finally, all carriers assume that a certain percentage of policyholders will lapse their policy. However, the industry has seen many instances where the policyholder is not the person to whom the policy was originally sold, and the policy is now owned as an investment. These policies are being kept in force, which unfavorably skews the prices for lapse assumption.
How does a COI rate increase affect a policy?
An increase in COI charges increases the overall cost of the policy. This means that if the policyholder wants to meet initially illustrated policy goals, an increase in the policy’s premium may be required. While an increase in the COI charges will reduce cash values of guaranteed UL (GUL) policies, it won’t impact the death benefit guarantee, so additional premium may not be required for GUL contracts where cash value is not a concern. Even though a COI increase on a GUL policy might not mean that the policyholder will have to pay additional premiums, if the cash value is decreasing, there’s less flexibility in the contract. That GUL may no longer have enough cash value to allow the policyholder to take a policy loan or effect a 1035 exchange.
What do policyholders need to do?
Understanding the policy details is crucial. A policy review is an opportunity to address COI increases and to understand how it may impact your goals. For some, the only alternative to paying higher premiums may be to request a reduction in the death benefit amount.
Pay special attention to policies with crediting interest rate that’s close to, or at, the guaranteed minimum crediting rate. Those policies may be causing the most stress for carriers. Request in-force illustrations at lower interest rates to help depict how sensitive the policy is to declining interest rates.
Review policies on a regular basis. It’s important to make that policyowners understand both current and guaranteed charges.