Cost of insurance charges for universal life policies are on the rise. That has big implications, not only for long-time UL policyholders, but also for life settlement companies and institutional investors that are looking to buy older UL contracts.
These were among the chief takeaways of an afternoon session of the 6th Annual Institutional Investor Life Settlement Conference, held at the Ritz-Carlton in New York City on Monday. Hosted by the Life Insurance Settlement Association (LISA), the session featured two life settlements experts: Michael Brohawn, managing director of ITM TwentyFirst; and Ann Marie Juliano, co-founder of Demeter Investments Ltd.
Brohawn said carriers’ ratcheting up of COI charges in 2015 — including a sixfold increase at one insurer — represent both an opportunity and potential pitfall for buyers and sellers of in-force life insurance policies in the secondary market.
“In the coming years, there will be a lot more life insurance policies entering the life settlement market because of these COI increases,” he said.
Cost of insurance (COI) charges — monthly charges for mortality, administration, marketing and other expenses — are assessed against a life insurance policy based on the insured's attained age, the original rating class, and the current net amount at risk. In most cases, carriers deduct the cost of insurance from premium payments before crediting interest to the contract.
COI increases were widespread in 2015, though they generally fell within a 5 to 50 percent range. Among the carriers that boosted charges: Aegon (up by 5 to 38 percent); Voya Financial (up 10 to 42 percent) and the Phoenix Companies (up 10 to 15 percent). The one outlier in the pack, Legal and General America (a unit of Banner Life Insurance Co.), boosted COIs by a jaw-dropping 95 to 600 percent.
What’s prompting the cost increases? Brohawn cited several factors, including headline risk (the possibility that a news story will adversely affect a stock's price), liquidity risk, regulatory and legal issues, unexpectedly low policy lapse rates, and — not least — low yields on insurers investments.
The last was evident in letters to insureds and investors that ITM TwentyFirst obtained in connection with the firm’s twin specialties, trust-owned life insurance (TOLI) and life settlements. Typical of the correspondence was a letter from AXA’s management, which noted in part that mortality and investment experience were “less favorable than anticipated when the current COI rates were established."
The operative terms in such carrier letters — “anticipated” and “expected” — are used widely to explain COI increases. The terms, noted Brohawn, also speak to troubles that were a long time in the making.
The most widely used product in life settlements, current assumption universal life, burst onto the market in the early 1980s, their popularity driven by flexible premiums and transparency. The components underlying the premium — mortality, administrative and marketing costs, plus agent compensation — could easily be determined and plugged into an illustration projecting premiums over the life of a policy.
In the early years, the policies also generated attractive rates for policyholders. Money market accounts were paying as much as 15 percent in the early 1980s — well above the low single digits of today. But the double-digit payouts, noted Brohawn, were a “market aberration.”
As a result, individuals who bought current assumption UL policies in the 1980 and 1990s — and who thought the rates would continue indefinitely — were destined to be disappointed. Crediting rates fell progressively in recent decades, to the point where old blocks of UL policies now pay no more than the guaranteed interest rate.
Of current assumption UL policies issued between 1996 and 2005, said Brohawn, 60 percent now pay only the guaranteed rate. The proportion rises to 78 among policies issued between 1980 and 1995.
The policy payouts fell in tandem with insurers’ return on investments, a decline that forced rises in premiums needed to keep policies in force.
The owners of under-performing UL policies, said Brohawn, are fueling in large measure policies that life settlement companies, backed by institutional investors, are buying up today. And a growing proportion of these policyholders are in their 80s.
“Ten years ago, 6 percent of the vehicles in our TOLI portfolio were set up by trust grantors over age 80. Today, more than 25 percent are above age 80 and 6 percent top age 90.
“The good news is that the life settlement market has a big tranche of policyholder prospects,” he added. “These people are the lifeblood of the industry.”
Premium increases are, however, a double-edged sword. Whereas rises in COI charges induce more seniors to consider a life settlement, the increases have also met with resistance. Among the opponents: (1) consumers who wish to hold onto their policies; and (2) institutional investors who have to pay more to keep contracts they’ve purchased in force.
In respect to the former, Demeter Investments’ Juliano said that policyholders have filed class action lawsuits against insurers that have raised COI charges. The Consumer Federation of America (CFA) has also voiced criticism of the carrier increases.
Institutional investors, for their part, have responded with financial and technical muscle to prop up earnings. Among the measures: “optimizing” policy portfolios by adjusting amounts paid for contracts based on (in addition to other variables) life expectancies of the insureds.
Nonetheless, increases in the cost of insurance will lead to lower investment returns. Referencing for illustration purposes a multi-carrier portfolio holding $43 billion in life policies, Juliano noted the COI increases instituted by 29 percent of the insurers between August and October 2015 would yield about a 1 percent lower return on investment for institutional investors. Assuming an additional 20 percent increase in COI charges among the affected policies, ROI for these investors would dip by an additional 180 basis points.
Should a further ratcheting up in the cost of insurance be expected? Brohawn believes so.
“Due to the continuing pressure on interest rates, the increases will likely continue,” he said. “Also, more regulation and bad calls by insurers on policy lapse rates will contribute to the rise.”
Many carriers in past years, he added, were left with poor-performing portfolios after policy conversions: high-risk/unhealthy individuals who converted term contracts for permanent policies with the same insurer. In other cases, healthier policyholders exchanged their contracts for life products paying better rates with another carrier.
That resulted in an imbalance between health and unhealthy insureds on the books of insurers paying lower crediting rates. In other cases, insurers ended up with unexpectedly high-risk portfolios after acquiring a block of business from another carrier.
Whatever the reason, some insurers (Banner Life among them) are now compensating for losses resulting from higher-than-expected mortality experience by ratcheting up COIs.
“If you're a carrier, the quickest and easiest way to boost revenue is by increasing the cost of insurance,” said Brohawn. “Given the pressures they're under, it's a lever they'd be glad to pull.
“The good news is that some insurers have said they won't raise COI charges,” he added. “There are economic incentives — including the need to acquire new policyholders and hold onto existing ones — for carriers to limit COIs on blocks of business.”
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