Low Mortality Assumptions Could Hurt Buyers Confidence In Life Industry
“Those who cannot remember the past are condemned to repeat it.”
This famous insight from the great philosopher and poet George Santayana is perhaps civilizations most important history lesson. And yet it appears that some factions of the life insurance industry have forgotten Santayanas words. They are flirting with marketing practices that could once again hurt consumer confidence in the industry.
Recent history shows that the industry received a hurtful black eye over certain marketing practices in the 1980s. At that time, interest rates were at historically high levels. It was fairly common for life insurance sales illustrations to be based on the assumption that double-digit interest rates would last forever. However, when interest rates dropped back into the single digits, some buyers were surprised to find they now had to pay premiums for longer than they expected or had to increase their annual premiums. Some buyers faced a combination of both higher premiums and longer payment periods.
The rest, as they say, is history. These unpleasant surprises–dubbed “failed promises”–led to Congressional hearings, numerous investigations and, in some instances, fines by state insurance departments and a flood of class-action lawsuits that cost the industry billions of dollars. Ultimately, the National Association of Insurance Commissioners adopted its Life Insurance Illustration Model Regulation.
The bottom line: consumer confidence in the industry was shattered; we are still picking up the pieces today.
Is History Repeating Itself?
Now, fast-forward to 2001. There is a disturbing trend on the horizon that, if not reversed, may subject buyers to another round of surprises and the industry to another loss of consumer confidence. The trend is the increasing use of very low mortality assumptions in the “out years” of sales illustrations.
The “out years” refer to 30 or more years from underwriting and issue when the insureds are aged 80 or older. These overly optimistic assumptions make the illustrations look very attractive–the same way high interest rates did. But, unless death rates drop dramatically from their current levels, buyers will once again wind up paying a lot more for their insurance than they expected.
Of course, its difficult to predict anything 30 years from now. Projecting mortality is no exception. So, there are some legitimate differences of opinion on what mortality rates will be for people who are then in their 80s and 90s–especially given the lack of good data that is available on insured populations. But some of the illustrations being generated today are based on such low levels of projected mortality, they seem rooted more in science fiction than science.
How Low Can You Go?
To figure out how reasonable or unreasonable estimates of future mortality are, we first need to develop a benchmark. But, given the lack of data that exists on insured lives, where do you get one? A fairly recent study by the Society of Actuaries on pension plan participants yielded a mortality table that was representative of mortality levels in the year 2000 (the RP 2000 table) and a set of factors (that they labeled “Scale AA”) for projecting mortality into the future.
The results of this study can be used as a reasonable benchmark to judge estimates of mortality in the “out years” of life insurance policies for several sound reasons:
1) The results are based on recent data.
2) The body of data is very large (more than 11 million life years of exposure and 190,000 deaths).
3) Most of the benefits of underwriting will have no affect 30 years from now.
Using this benchmark, some companies illustrations reflect insurance charges at ages 80 and above that are 40% to 60% below what the RP2000 table indicates. That holds even if you were to reflect only the experience of the healthiest subset of the retirees (i.e., healthy retirees who are getting the largest monthly benefits) and assume that mortality continues to improve into the future (using the Scale AA).
To achieve those levels of mortality, the annual rate of mortality improvement going forward would have to average 300% to 400% of the rather impressive rate that the industry has enjoyed over the last 15 to 20 years. (The examples cited above are based on illustrations for a recently underwritten male who is now aged 45.)
Why would some life insurers become so aggressive in projecting “out year” mortality assumptions? There are at least four potential reasons.
1) It makes their sales illustrations look great. Sales illustrations are very sensitive to the mortality that insurers assume in the “out years.”
2) There isn’t a lot of older age mortality data available on insured lives, so some actuaries may have projected mortality based on whatever life insurance data they could find and never tested their end result against other tables, like the RP2000. (For example, some may have blindly used a level percentage of the 75-80 Table for all policy years without checking to see if the end result passed a “smell test.”)
3) It’s difficult–if not nearly impossible–for the average consumer to detect overly aggressive assumptions. Unlike interest rates, where buyers should have had some sense of whether 12% or 14% was a historically sustainable interest rate, very few buyers have any way to judge the reasonableness of an insurer’s mortality assumption.
4) Current management will be long gone by the time any flawed mortality assumptions blow up. If an insurers mortality projections are eventually proven too optimistic, most of the managers who benefited from making these assumptions will have retired when the insurer is forced to deal with the consequences.
Where Do We Go From Here?
In today’s competitive world of the spreadsheet, insurers that base their illustrations on more moderate mortality assumptions (thereby leaving more margin for pleasant surprises in the future) are losing sales to insurers that attract buyers with aggressive assumptions about ultimate mortality levels.
So, what do we do? Insurers as well as their distributors (who are knowingly or unknowingly participating in the practice) need to take concrete steps to ensure that the overly aggressive marketing practices of a minority of insurers don’t once again destroy the public’s confidence in the industry. Here are some starting points:
Life insurance carriers should ask their product and marketing people to take a hard look at the level of charges they are using in sales illustrations. Sales illustrations should be used to give prospective buyers a reasonable estimate of what their coverage might cost–not low-ball them.
Life insurance distributors should ask their carriers to justify the level of charges in the “out years” of sales illustrations. The cost of insurance charges should be expressed as a percentage of the RP2000 table or other relative benchmark. Every distributor owes it to their clients to understand how aggressive or conservative their sales illustrations are to a reasonable benchmark.
By the way, its insufficient for the rates in the illustrations to merely be consistent with reinsurance rates because reinsurers almost always have the right to raise rates.
Life insurance executives need to consider using a uniform set of insurance charges in the “out years” of illustrations. Insurers shouldnt necessarily be forced to charge the same amount. But they should be required to base their illustrations on a common set of insurance charges for the “out years,” that is, 25 or 30 years into the illustration.
Without such a standard, Company A’s product can look a lot better than Company B’s not because they really do have lower expenses, better investment returns or lower claim levels (due to tighter underwriting), but simply because they are more aggressive in their estimates of future mortality.
This trend must be stopped. Otherwise, the life insurance industry will be condemned to repeat one of the more unfortunate episodes of its history.
, CLU, FSA, is vice president and director of individual life product development and marketing at Hartford Life. He can be reached at email@example.com.
Reproduced from National Underwriter Life & Health/Financial Services Edition, July 20, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.