Low interest rates have diminished the profitability of level cost universal life insurance for years. Although fierce competition may have overruled common sense for some time, manufacturers no longer have a choice. Long-term interest rates have finally forced changes.

Based on outdated actuarial assumptions, level cost universal life insurance needed a serious overhaul to return to profitability. After bottoming out in 2008, long-term interest rates once again fell below 3.5% just before year end. This drop, one of many, finally convinced actuaries. A major player hiked its prices in December, and several rivals followed.

Long-term interest rates guide actuaries’ pricing of permanent products with guaranteed premiums. Level cost universal life is one example. In the first few years, the premiums received from insured surpass the claims payable. A few decades later, the pendulum swings in the other direction. Insurers must therefore invest the premiums received early on in long-term government bonds to offset future shortfalls.

This prudent approach also characterizes many other permanent products such as participating whole life insurance and T100 term insurance. Little influenced by interest rates, yearly renewable term UL insurance has avoided rate increases. On the contrary, this short-term temporary product is priced to follow the evolution of the mortality curve.

Faced with anemic profitability of level cost products, insurers have long been dreaming of raising prices. Several players had not reviewed their interest rate assumptions since the mid-1990s.

On Dec. 4, Manulife Financial raised its level cost product. It was not the first to do so, but it triggered a domino effect. Industrial Alliance boosted its level cost on Jan.17. Sun Life Financial followed on Jan. 28 and Canada Life did the same on Feb. 7. Empire Life announced that it would make a similar move during the first quarter.

“We were seeing long-term rates decline in each of the first nine months of 2010. It had become clear that the rates would not return to their previous levels. But the market is very competitive. When one decided to raise rates, the others said ‘finally,’” Yvon Charest, president and CEO of Industrial Alliance, told The Insurance and Investment Journal. With this generalized increase, he thinks the industry has solved its interest rate problem for 2011.

Sun Life explains the increase to its advisors on its website: “Interest rates have continued to fall, with long-term Canadian bond yields falling to their lowest levels in recent history…This continued low interest rate environment puts pressure on margins for permanent guaranteed level cost of insurance products…We are taking action to ensure our products maintain their value for clients, advisors and shareholders.”

Transamerica Life Canada acted last year, but its initiative made few ripples. The insurer adjusted the level cost of universal life for insurance amounts of up to $500,000. Standard Life Canada increased its level cost five years ago for profitability reasons.

At Manulife, the increase affects the Innovision, UltraVision Security; and Sun Limited Pay products “We’ve changed the rates 10% on average, dependent on which products, ages, and female-male distinction. It increased the most for joint last-to-die policies, younger ages and female. The increase has been smaller for male and older persons,” says Steven Parker, assistant vice-president for product and marketing of individual insurance and living benefits at Manulife.

On April 1, Manulife plans to revise the guarantees on the long-term investment options of its universal policies. It will reduce the guaranteed rates by 50 basis points. For example, the guaranteed interest rate on the 20-year option will dip from 3% to 2.5%. In the same quarter, the insurer also intends to increase the price of its T100 products Signet and Family Term.

The rise in level cost UL had become inevitable, Mr. Parker continues. “Level COI was priced 15 years ago and has almost not been readjusted since, while long-term interest rates decreased almost half from where they were then. They just weren’t sustainable anymore. The actual pricing is more in tune with what is happening in the economic environment,” he explains.

One example: when Manulife launched Innovision in 1994, the insurer could invest in 20-year Canadian government bonds paying 8.7% interest. “For a male non-smoker aged 45, you could have this UL for $1M coverage at $7,500 annual premium (cost of insurance only). The premium was $7,400, just before the repricing. Meanwhile, interest rates are half what they were,” Mr. Parker points out.

Major shift

Industrial Alliance is applying an 8% to 10% increase for the Genesis and Genesis-IRIS products, Mr. Charest of Industrial Alliance confirms. “For a long time, there have been small sideways rate movements. We can now say there’s a major shift going on,” he says.

At Sun Life, advisors were informed of an average increase of 8% in the level cost of SunUniversal Life and SunUniversal Life MAX products. However, it may reach 14% for insured ages 16 to 49 who procure coverage of $250,000 and up. Conversely, the rate is 3% lower for clients ages 50 and up who are insured for less than $250,000.

For the limited payment product, the average increase is 5% with a 6% peak for longer terms. This is the second time Sun Life has tweaked this product upward “The December 2009 price increase for Sun Limited Pay was the first step in mitigating the impact of the low interest rate environment. Since then, interest rates have continued to decrease so further action is necessary…,” the company says.

“Interest rates [and equity markets] are at the top of mind for all of us in the industry. We always keep an eye on those things. Decline in interest rates put pressure on the profitability margins for permanent insurance. So, it’s fairly well known that level COI was underpriced in the current environment,” says Kevin Strain, senior vice-president, individual insurance and investments at Sun Life.

He lauds the recent mass movement. “We find it encouraging that the industry is adjusting the pricing to a more profitable level for the companies.”

For its Millenium product Canada Life has implemented an average pricing increase of 10% for the level cost of insurance option and 5% for limited-pay COI among other changes, explained a memo from the insurer.

The low interest rate phenomenon has put enormous pressure on insurers, says Robert Mallette, an independent actuary associated with NMG Group. The firm helps reinsurers and insurers produce business plans and conducts market studies to evaluate the quality of their product and service offering.

“For ten years, insurers have successfully kept prices in check by realizing gains from other sources that compensated for falling interest rates,” Mr. Mallette says. He adds that insurers should have increased the price of level COI a lot sooner, but were deterred by competition. Now that rates have sunk to a historic low, this market should see raises for the next few years. If interest rates continue to decline, the level cost product will become less attractive for clients than the yearly renewable term product, he says.

Mr. Mallette sees the industry returning to more balanced product portfolio. “When I was an actuary at NN Financial Services in the 1990s, level cost products accounted for 95% of sales, and yearly renewable term for 5%. In the past four or five years, the proportions evened out,” he says. Mr Mallette also worked as an actuary at RGA Canada until 2006.

At first, all universal life insurance sold was in the form of yearly renewable term policies, Mr. Parker of Manulife recalls “UL was all YRT in the beginning. Overtime, level COI began to dominate: it accounts for over 70% of the UL market in Canada today,” he adds.

Sun Life was among the insurers that aimed for a more balanced product portfolio “We did a lot of things in the past couple of years to reduce our interest risk. We’ve changed our product mix. We were selling more term, CI and LTC, and bringing a par product to the market. Repricing of UL helped as well.” Mr. Strain explains.

A varied product mix is essential because products have different sensitivities. Some are more sensitive to mortality rates, while others are affected by interest rates. Some products are priced according to the future policy lapse rate, while others are more sensitive to the expense ratio. Still other products are heavily exposed to stock market returns.

“We want to make sure we align the products to the client’s needs and to the economic environment. Five years ago we were selling mainly UL. Today, it accounts for less than 50% of our sales,” Mr. Strain says.

The new International Financial Reporting Standards (IFRS) may also affect long-term products. Yet Mr. Charest thinks the problem is at least partly solved.

“The exposure draft on IFRS phase 1 has been scrapped: separation of assets and liabilities is no longer up for discussion. The International Accounting Standard Board (IASB) is seriously analyzing three methods, including the Canadian one,” Mr. Charest says.

He doubts that the IASB can meet its 2013 deadline. “The IASB has given itself until mid-2011 to produce a definitive exposure draft. Knowing how long it takes to reach a consensus among regulatory organizations around the world on detailed standards, we don’t think this deadline is realistic,” he says.

If the standard intended to appraise reserves at fair market value seems to have been scrapped, the use of a prudent rate could lead to a standard that creates a slew of problems, Mr. Mallette says. If the prudent rate proposed by the IASB is lower than the current rates, insurers will have to add to reserves that support the level cost product, he explains. This will increase liabilities, and these funds cannot be used elsewhere. He calls this an opportunity cost.