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, mortalityof 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 ile UL contracts for state approval, the iling 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 underperforming 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 of 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.
Magnifying the impact of anti-selection is pricing error, the influence of which cannot be overstated. In this situation, some policies had pricing or design capabilities that many brokers thought were advantageous for their clients. When the brokerage community identified these opportunities, they had the habit of “driving a truck through” that carrier’s pricing hole. For many carriers, these openings allowed for the sale of an unexpectedly large number of unprofitable 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 DO CARRIERS RESPOND TO PRICING PRESSURES?
In the light of all of these pricing pressures, carriers who are holding a block of unprofitable policies only have a few options. Those options can be viewed as “levers” that the carrier can pull within the policy to try to recoup costs. For example, if the unprofitable block of policies is made up of whole life policies, the carrier might reduce the dividends paid on the contract. Because whole life contracts are priced and designed with many contractual guarantees, the carrier’s only “lever” is in adjusting the dividend.
Like whole life policies, UL policies only provide carriers with limited options when dealing with incorrect pricing assumptions. The response available to UL insurance carriers comes not through adjusting dividends, but through increasing COI rates, which they reserved the contractual right to do when they iled the policy for state approval. This response is reflected in the recent announcements of increases to COIs charged on in-force UL contracts.
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.
HOW DO CARRIERS AVOID COI INCREASES?
Historically, carriers have avoided increasing COI rates, as doing so could place them at a competitive disadvantage on new sales. Increasingly, carriers are tightening expenses on current operations. They may also price new products higher to help compensate for pricing pressures. Advances in technology will help reduce some of the carriers’ future overhead costs. A recent trend among carriers – to mitigate policyholder anti-selection from term conversions – is to limit the number of years available for conversion to their full suite of permanent products, with only a specific product that’s generally priced higher ofered thereafter.
Insurance carriers realize that it isn’t in the best interest of anyone to increase COI rates or other policy charges. Carriers will continue to invest in policy management systems and tools to help give you and your clients a clear understanding and clear expectations of in-force policies.
WHAT ARE SOME RECENT INCREASES?
The following carriers announced increases to the COI rate and/or other charges on in-force UL policies. Here’s what happened:
| EFFECTIVE DATE | CARRIER | ISSUING CARRIER | NUMBER OF POLICIES IMPACTED/ RATE INCREASE | POLICY YEAR OF ISSUE |
|---|---|---|---|---|
| June 1, 2015 | Transamerica | Transamerica Life Insurance Co. | Not available | Select policies issued from 1987 – 1998 |
| Aug. 1, 2015 | Legal and General | Banner Life William Penn | Not available | Select policies issued from 1995 – 2010 |
| Sep. 1, 2015 | US Financial Life | US Financial Life | Not available | Not available |
Oct. 1, 2015 | VOYA | Security Life of Denver Reliastar Life Insurance | Number of affected policies is not available; COI rate increase ranges from 9% – 42% | Select policies purchased prior to 2009 |
| Jan. 1, 2016 | AXA | AXA Equitable Life Insurance Co. | Approx. 1,000 policies Issue Ages: 70+ Face Amount: $1M+ | Select policies issued from 2004 – 2008 |
WILL THERE BE MORE COI INCREASES IN THE FUTURE?
For competitive reasons, carriers will continue to be very reluctant to increase COI rates. But this doesn’t mean that a carrier’s particular situation might not push them to increase COI rates. It’s possible the industry will see more increases on select blocks of business. Carriers that have acquired other life insurance blocks of business may find they have no alternative, given how policies were originally priced and/or sold. It’s important to remember that a low interest rate environment doesn’t necessarily guarantee more COI increases.
SUMMARY
- As a result of a unique set of economic factors, a select few life insurance companies have increased COIs on specific products.
- We believe that the above cost of insurance increases are the exception and not the rule.
- We will continue to monitor the industry and carrier actions and keep the advisor community abreast of significant changes.