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).