Industry struggles with profitability of level cost universal life

By Andrew Rickard | October 18 2007 04:06PM

How much longer can companies keep missing profitability targets on their level cost of insurance universal life products? The Insurance Journal asked several industry players for their take on subject.

In a pricing survey conducted by Munich Re Canada last year, fewer than 10% of insurers said that their level cost of insurance (COI) universal life insurance (UL) products were meeting profitably targets. If interest rates remain low, price increases seem inevitable.

John Dark, an assistant vice-president and product actuary at The Co-Operators in Regina, points out that central banks the world over remain focused on fighting inflation. That means low interest rates will continue, and low interest rates mean reduced earnings for insurers.

"Because level COI requires insurers to make long term promises about rates now and in the future, most carriers will focus the bulk of funds backing these guarantees on fixed income investments," he explains. "Essentially the long rates have been decreasing since the advent of UL and the trend appears to be that they will stay in this low range. The post war inflationary period appears to have been an anomaly."

Besides interest rates, Mr. Dark also believes that lower than anticipated lapse rates may also be biting into some insurers’ level COI universal life profits.

Lower lapse rates

"There is growing evidence that the longer term lapse rates will be lower than originally thought," he says. There are even industry studies that show no lapses at all in certain cells, although he adds that the data is still relatively new. While the products do have some differences, level COI has many of the same characteristics of the risk profile to an insurer as a book of Term 100 business, so he believes lessons can be drawn from that experience. "Most of your readers are quite familiar with what happened there," he says.

It’s odd to think that clients are now paying higher prices for their level COI universal life insurance coverage because brokers placed quality business in the past, but that seems to be the way it is working out.

"I think that advisors are doing a very good job keeping business on the books," says Gerry Anthony, senior consultant, product development at Standard Life Canada. He notes that someone who purchased a level COI product for a good reason is unlikely to lapse their policy later on. "There’s no way they can replace it with a less expensive product on the marketplace ten years down the road," he says.

So if margins are thin and lapses are low, why have some life insurers been reluctant to initiate changes? When Standard Life, a major player in the Canadian level COI universal life market, increased rates in late 2005 to address profitability concerns, why didn’t the rest of the industry follow suit?

"In all honesty, we were a bit surprised that there was not a general move upward in the pricing," says Mr. Anthony. He notes that level COI universal life represented a significant portion of Standard Life’s portfolio. The fact that other companies had a wider range of products or more in-force business may have allowed them to hold out longer. He also suggests that some of his competitors may have decided to keep their level COI universal life rates lower even as profits eroded because they were "a bit covetous of market share."

"People do not want to lose market share," agrees Peter McCarthy, president and chief executive officer of AIG Life Canada. While a public company may be prepared to accept lower margins in exchange for top line growth, that kind of situation can’t go on indefinitely.

If the low interest rate environment continues, people will have to make changes to keep their shareholders happy and, perhaps to the detriment of clients, rates will rise," says Mr. McCarthy. "Eventually, in an efficient marketplace, rates return to where they should be." But he emphasizes that in a highly competitive market like Canada, it can sometimes take longer than expected for macro economic factors to work their way into premium rates.

Peter Wouters, director of tax and estate planning and risk product marketing at Empire Life, characterizes the recent round of rate increases he’s seen as relatively minor recalibrations. "It’s been some tweaking more than anything else," he remarks.

In his opinion, the price jump has not been significant enough to put consumers off the product. "It isn’t enough of a detriment to say, ‘I don’t want the strategy anymore,’" he says.

Slightly higher costs don’t necessarily cancel out the benefits of whatever UL insurance solution the advisor may be proposing to a client. "If it’s something they really need, I think they’re prepared to come up and say, ‘Yes, I’ll pay that,’" comments Mr. Wouters.

It remains to be seen if rising level COI costs will drive more customers towards UL plans that use yearly renewable term (YRT) as insurance.

Two different purposes

Mr. Anthony says that in his experience, YRT universal life products and Level COI products tend to be sold by two different types of advisors. YRT Life is often positioned as a wealth accumulation vehicle, while Level COI tends to appeal to those who are more concerned about offering long term insurance protection. The former is not a perfect substitute for the latter. "I think there’s still going to be a place for level COI," he says.

Mr. Dark of The Co-operators doesn’t expect a dramatic shift away from level premiums either, since many of the people who are attracted to guaranteed rates will still not find YRT acceptable.

"The scariest part of the YRT COI for people is what happens at advanced ages. Illustrations show substantial balances building up near life expectancy and then rapidly decreasing. This has turned many people off of YRT," he notes. "The reality is, though, that such an event is many years in the future and few if any of the policyholders who buy today will have their policy in the same form 30 years. As level COI prices rise, some people will find the YRT proposition of more value. That will take time to manifest itself and I don’t expect a big swing in 2008."

Rate increases

So when should advisors expect insurers to make further increases in their level COI rates?

"I would have expected them to start doing so already," says Mr. Anthony. He adds that insurers with a large book of participating life insurance business could become even more concerned about profitability within the next ten years. "You’re probably going to be seeing a fairly substantive decrease in dividend scales," he says. "The long bonds are starting to come up [for renewal] and you’re not getting 12% money anymore."

Mr. Dark says he frustrates members of The Co-Operators’ field force by replying to questions like this by asking, "How long is a piece of string?" He believes it’s almost impossible to predict precisely when rates will rise because there isn’t enough publicly available data.

He suggests those contemplating the future of the level COI universal life market consider other factors. How many insurance companies actually wanted to raise rates more than they did but felt competitive pressure to hold the line on the increase? How many more companies who haven’t changed will increase their rates? How many companies will move away from the "pure" level COI form of charge to one with guaranteed minimum cash values – a product which essentially removes much of the lapse subsidy?

Mr. Dark doesn’t offer any responses to these rhetorical questions, but he does say that his personal belief is that level COI rates will increase sporadically for some time. "If I was planning on buying a level COI universal life policy at some point in the future, I’d buy it now."

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