Principle Based Reserving May Affect New Life Insurance Policy Pricing Going Forward

A new methodology for calculating policy reserves for life insurance policies has taken effect. The new methodology grew out of the 2009 National Association of Insurance Commissioners (NAIC) revisions to the Model Standard Valuation Law. Dubbed Principle-Based Reserving (PBR), the law was to take effect on the first day of the next calendar year if 42 states enacted the revisions by July 1st. The threshold was passed in 2016 and as of today, 46 states have adopted the revised laws.

Insurance companies are required to set aside reserves to pay future claims, and the reserve requirements are specified by state regulation and laws. The current method of reserving will remain unchanged for in force business, as PBR only affects policies issued on or after January 1, 2017. However, life insurers will have three years to implement the new methodology. Currently, the requirements will be altered for life insurance policies only, but over time they are expected to apply to other products as well.

According to information provided by the NAIC (1), the new approach will lessen the need for changes to regulations and laws as new products are introduced. Under the new methodology, states would “establish principles upon which reserves are to be based rather than specific formulas.” Under the current formula, the risks, liabilities and obligations are not always correctly “reflected,” and “for some products this leads to excessive conservatism in reserve calculations, for others it results in inadequate reserves.” A study by the NAIC disclosed the new method will lower reserves for competitive level premium term insurance. Universal life policies with secondary guarantees will see both “higher and lower reserve requirements,” which was not unexpected, “given the variations in company interpretations of the reserve requirements for this product type that were in effect when this study was done.” Per the study, reserves for most other products, including current assumption universal life and whole life, will remain relatively unchanged.

Reserve requirements are only one of the many factors affecting the pricing of life insurance. Others factors include mortality expenses and investment returns, along with overhead expenses, other than reserving.

While it remains to be seen exactly how pricing will be affected, the NAIC believes the “right sizing” of reserves will benefit consumers since holding higher reserves tends to increase costs, and holding reserves that are too low puts the consumer at risk. The new regulations will also allow for the introduction of new products that could offer multi-benefits and more flexibility for consumers.

For those of us managing in force life insurance, the new methodology will change little, though new and replacement products going forward may be more or less attractive because of pricing changes.

1.) PBR Educational Brief, June 21,2013, The National Association of Insurance Commissioners, and The Center for Insurance Policy and Research

TOLI Trustees Need To Be Aware Of Life Settlements

It is estimated that every year, seniors in the US surrender or lapse over $112 billion dollars in life insurance death benefits (1). Most of them probably have no idea of their options, but grow tired of the premium payments and walk away without maximizing the value of an asset they may have paid for over a lifetime. For the uninformed consumer, this could be just a lost opportunity, for the Trust Owned Life Insurance (TOLI) trustee, this can be a source of potential liability.

An alternative to a policy lapse or surrender is a life settlement, the sale of a life insurance policy for a lump sum greater than the policy’s cash value and less than the death benefit. The purchaser of the policy will maintain the policy by paying the policy premium until the death of the insured.

The life settlement industry grew out of the “viatical” movement of the of the 1980s when AIDS victims were given the opportunity to sell their life insurance policies to a third party for a lump sum payment to be used to provide medical and other care in the final years, sometimes months, of life. Advances in the treatment of AIDS made these types of policy sales less common, but the idea of life insurance as an asset that can be sold grew into the life settlement, or secondary marketplace, we see today.

Originally the industry was lightly regulated and some who sold their policies were taken advantage of, but today’s life insurance settlement marketplace is heavily controlled. The vast majority of states (42) have strict regulations that provide a framework for the orderly transfer of policies, with required consumer disclosures that protect the policy seller. The improved regulations have dramatically decreased issues in the sales process.

For the TOLI trustee managing life insurance today, life settlements are an option that must be considered. Because of changes in the estate tax, increased policy costs, and the natural evolution of trust goals, there are more “unwanted” policies to deal with than ever. Those of you who have attended our ITM TwentyFirst University sessions in the past know that we have developed many methods for analyzing options to maximize the value of a life insurance policy. We do this because it is our clients’ (TOLI trustees) responsibility to maximize the value for their clients (life insurance trust beneficiaries), and life settlements can be a way to do that.

Typically, life settlements are available to insureds age 65 and older, though health will play an important role in whether an offer is forthcoming. Most policies sold are universal life policies – especially current assumption universal life, though other policies, even term insurance policies that can be converted to a permanent policy, can be sold. The offers depend on the death benefit of the policy, the annual premium needed to carry the policy, the life expectancy of the insured, and the rate of return that the buyer needs to make the purchase a viable investment.

The sale of a policy has potential tax implications to the seller. A life insurance policy held in trust until a death benefit is paid is received income and estate tax free, however if a policy is sold there is a possible tax liability to the trust.

While all the advantages and disadvantages of a policy sale are beyond the scope of this article, we believe that the full discussion of life settlements in the TOLI world is important enough to schedule a webinar session that will provide a TOLI trustee (and all financial professionals) with a thorough understanding of the process. Our next free webinar session, entitled Learning When Why and How to Do a Life Settlement, will be held on March 28th at 2 p.m. Eastern Time, and will provide one hour of continuing education for CFP, CTFA and FIRMA members. You can register here.

  1. LifeHealthPRO, February 25, 2015, Forfeited Life Insurance Benefits Pegged at $112 Billion

Transamerica (Again) Restricting Inforce Illustrations On Certain Universal Life Policies

In November of 2015 we published a blog noting that Transamerica was no longer providing inforce illustrations with “current assumptions” on a number of universal life policies.  We pointed out the challenges that raised in managing policies without an understanding of “what Transamerica is actually charging and crediting” in the policies.

This week, Transamerica announced that beginning March 15th they would “only run illustrations based on the guaranteed maximum charges and the guaranteed minimum interest rate” on another block of inforce policies.

Per the carrier, the “decision was made following significant review of NAIC regulations” relating to current assumption inforce illustrations and their “interpretation of those NAIC regulations.”

For the affected policies, Transamerica will provide only the current accumulation value of the policy and the current monthly deduction amount.  The policy owner (or servicer) will then have to compute whether the current policy premium will be sufficient to “sustain the policy until the next anniversary.”

This announcement follows a similar announcement by John Hancock that we noted just last month.  In that blog entry, we mentioned that we did not “wish to speculate on the future actions” of the carrier as to future COI increases and we will not here.  But we would be remiss if we did not point out that the notice from Transamerica in November of 2015 was a precursor to COI increases we uncovered in February of 2016 on the very same policies.

As always we will provide updates as warranted.

Illustration Restrictions Placed On Some John Hancock Inforce Policies

In the past we have written about limitations on obtaining ledgers to manage inforce life insurance.  In one instance the inability to provide in-force ledgers based on “current assumptions” was a precursor to a cost of insurance (COI) increase.

Our servicing team recently received notice that due to a “temporary” situation John Hancock cannot provide inforce ledgers on its Performance UL Policies issued in particular states from 2003 to 2010.

According to the information received from the carrier, they are unable to provide this information because “regulatory standards that govern illustration practices…prevent us from illustrating currently payable amounts based on our current non-guaranteed elements.”

John Hancock is “reviewing the non-guaranteed elements applied to these Policies because emerging experience has differed from the current assumptions which are reflected in the illustrations” and it expects the review to be completed “in the first half of 2017.”

The carrier notes that if the review results in “changes to Non-Guaranteed Elements such changes will not take effect before the policy anniversary immediately after the completion of the review.”

While we do not wish to speculate on the future actions of a highly rated and respected carrier, we will be closely monitoring the situation.

Second Amended Complaint Filed In The Brach Family Foundation Lawsuit Against AXA For Cost Of Insurance Increase

Late last week, a Second Amended Class Action Lawsuit was filed in the United District Court, Southern District of New York in the Brach Family Foundation vs. AXA Equitable Life Insurance Company case we first wrote about on February 2, 2016.

The 35-page document expands and adds to the original 18-page Class Action Complaint filed February 1 of last year, and follows on the heels of two unrelated lawsuits filed against AXA last week.

The suit, brought on behalf of the foundation and “similarly situated owners” of Athena Universal Life II policies subjected to the COI increase, alleges the increase was “unlawful and excessive” and that AXA violated “the plain terms” of the policy and “made numerous, material misrepresentations in violation of New York Insurance Law Section 4226.”

The rate hikes, which were applied in March of last year, were targeted to a group of approximately 1,700 policies issued to insureds with an issue age of 70 and up, and with a policy face amount of $1 million and up.  Since the increase was focused on this “subset”, the suit alleges that the increase was unlawful because the policies require that if a change in rates occurs it must be “on a basis that is equitable to all policyholders of a given class.”   The suit points out that there is no “actuarially sound basis” to treat policyholders differently simply because one may be 69 and one 70 at issue age, or because one may have a policy with a face amount above or below $1 million. The suit also points to actuarial studies that indicate there are actually “lower mortality rates for large face policies.”

The suit notes that there are six “reasonable assumptions” that COI changes can be based on: expenses, mortality, policy and contract claims, taxes, investment income, and lapses. AXA has stated that the COI increase was based on two of those: investment experience and mortality.

In order for the increase to be “based on reasonable assumptions” for investment income, the increase has to “correspond to the actual changes in investment income observed,” according to the lawsuit, which points out that “since 2004, there has been no discernible pattern of changes in AXA’s publicly reported investment income” that would “justify” any type of COI increase.

AXA defended its increase, in part, by stating that insureds in these policies were dying sooner than projected. However, the lawsuit claims that “mortality rates have improved steadily each year” since the policies were issued.   According to the lawsuit, the Society of Actuaries has performed surveys comparing observed mortality of large life insurance carriers to published mortality tables and has found that the “surveys have consistently showed mortality improvements over the last three decades, particularly for ages 70-90.”  The suit points out that AXA informed regulators in public filings as late as February 2015 that it “had not in fact observed any negative change in its mortality experience,” and answered no when asked if “anticipated experience factors underlying any nonguaranteed elements [are] different from current experience.”  When questioned whether there may be “substantial probability” that the illustrations used for sales and inforce purposes could not be “supported by currently anticipated experience,” the carrier again answered no.

The suit alleges that if AXA’s “justifications” for the COI hikes are valid, “then AXA applied unreasonably extreme and aggressive haircuts to the 75-80 mortality table when setting original pricing of AUL II, and these pricing assumptions were designed to make AXA’s product look substantially cheaper than competitors’ and gain market share” and by doing so, AXA engaged in a “bait and switch” which resulted in “materially misleading illustrations, including all sales illustrations at issuance” in violation of New York Insurance Law Section 4226(a).

By focusing the increase on older aged insureds, the suit alleges AXA “unfairly targets the elderly who are out of options for replacing their insurance contracts” and forces the policyholders to either pay “exorbitant premiums that AXA knows would no longer justify the ultimate death benefits” or reduce the death benefit, lapse or surrender the policies.  According to the lawsuit, any of these actions will allow AXA to make a “huge” profit from the “extraordinary” COI increase.  According to the lawsuit, AXA originally projected that the COI increases, which ITM TwentyFirst has noted ranged from 25-72%, would increase “profits by approximately $500 million.” The lawsuit also notes that in its latest SEC filing, the carrier said that “the COI increase will be larger than the increase it previously had anticipated, resulting in a $46 million increase to its net earnings,” which the suit points out is “in addition to the profits that management had initially assumed for the COI increase.”

For a copy of the Second Amended Class Action Lawsuit in the case, contact mbrohawn@itm21st.com

USAA Settles Class Action Lawsuit Over Cost Increase In Term Policies

Last week, our Cedar Falls, Iowa, office received notice of a class action lawsuit settlement. The settlement, stemmed from a suit filed in Alabama, Erkins v. USAA Life Insurance Co.

According to a complaint filed on October 20, 2015, (1) Moses Erkins purchased a “Level Term Life Policy” with premiums designed to remain fixed for the “Level Benefit Period.” The $250,000 policy had a 20-year level death benefit period with a $1,025 “current” premium. After the 20- year period (up on July 20, 2017), the $1,025 annual premium would purchase a decreasing amount of insurance. The $1,025 premium cost was guaranteed for the first 5 years only, after which premium costs could increase.

The policy contract listed both the current and guaranteed premium cost of coverage, but according to the complaint filed, the policies were sold by USAA with “Current Premiums set substantially less than the maximum guaranteed premium and, with the Defendant’s stated expectation that the Current Premiums were planned to remain the same for the full duration of the contracts. Otherwise, the Policies would be prohibitively expensive and could not be marketed as they were.”

According to information provided in the settlement, (2), USAA did not “increase premium rates on any of the policies … before the end of the Level Benefit Period, but a premium increase” was “planned to take effect after the Level Benefit Period.” The plaintiff argued that in order for USAA to increase the costs in the policy it could only do so based on “expectations of future changes in mortality experience, expense experience” or “investment performance change from those expectations used in the original pricing of the Policies.”

The court did not rule in favor of either USAA or the plaintiff, instead a settlement was reached. According to settlement information, USAA agreed to provide “Settlement Class Members who submit a valid and timely claim form either a two-year term certificate or a single payment of varying amounts,” depending on their category.

In addition, USAA agreed to “provide additional written notice to all In-Force Policy Owners to inform them that their premium will increase after the Level Benefit Expiration Date.” They also agreed that there would not be any “additional re-pricing of the Policies for five years after the Effective Date of the settlement.”

It is unfortunate that the court did not rule in this case to provide us with some guidance on the issue of cost increases in life insurance policies. USAA, founded to provide a wide array of services for military member and their families, has consistently garnered high ratings from many consumer groups over the years and given the relatively small amount that they had to pay out, it is understandable why they decided to settle.

  1. Moses Erlins v USAA Life Insurance Company, Circuit Court of Barbour County Alabama, 10/30/2015
  2. LevelTermPolicySettlment.com

 

Latest Federal Reserve Hike Viewed as Generally Positive for Life Insurance by Moodys

Less than two weeks ago, we reported that Moody’s had downgraded its 2017 outlook for the life insurance sector from Stable to Negative. A new Moody’s report published after the Federal Reserve raised its benchmark federal funds target rate by 25 basis points last week indicates that hike will benefit life insurers and “help reverse the downward march in investment portfolio yields.” (1)

The federal funds rate is the interest rate that depository institutions charge each other for an overnight loan. Banks are required to keep a minimum reserve requirement and will move monies back and forth, charging a rate based on the target rate set by the Federal Open Market Committee (FOMC), which is the Federal Reserve’s primary monetary policymaking body.1-fedres2

As can be seen in the graph to the right,
the federal funds rate that is actually charged dropped dramatically through 2008 as the target rate sank and stuck at 0 to .25 percent. A bump in December of 2015 pushed the target to .25 to .50 percent. Last week’s increase pushed the target rate to .50 to .75 percent.

While the rate only pertains to overnight loans among very creditworthy financial institutions, its effect is actually broader since banks use it for the basis of all other short-term rates. It also indirectly affects longer-term rates, such as home mortgages. An article in the Wall Street Journal yesterday declared, “The era of the ultralow mortgage is over.” It also pointed out that after the US election, even before the Fed acted, rates on a 30-year mortgage jumped .76 percentage points, to 4.38%, (2) the “post U.S. election bump in yields” we mentioned in our prior blog.

The increase in long-term rates would be a welcome relief to life insurance carriers who have struggled mightily in this low interest-rate environment. Insurance companies attempt to match their investment time horizon with their liabilities, and life insurance is a long-term liability. The Moody’s report points out that “new money rates on long-duration investments are more important for insurers,” a good benchmark for new money rates of life insurers being the 10-year treasury plus a credit spread, which has seen a “100 basis point rise…from… summer lows.”

Should the long-term rates become sustainable, Moody’s sees the profitability of older annuity blocks improving and believes “interest-sensitive life insurance,” like universal life, would benefit, along with other “long-tailed specialty products” like long-term care, both of which have seen dramatic cost increases in the last few years. With increased rates, the pressures on carrier reserves would lessen, and the chances of GAAP charges and write downs would decrease.

The Moody’s report believes this might be a first step toward a “more normalized policy rate environment that would be conducive to better long-term operating conditions and profitability.” Let’s hope so, but let’s also remember that the current target rate hike, only the second in 8 years, only pushed the rate from .50 to .75 percent. A decade ago, a “normal” fed funds rate was 5.25 percent. We are a long way from that.

  1. Moody’s Sector Comment, December 14, 2016, Financial Institutions, United States
  2. Rising Rates Ripple Through Mortgage Market, Wall Street Journal, December 19, 2016