Many life insurers are retooling universal life policies having secondary death benefit guarantees in response to Actuarial Guideline AXXX.
Implemented in 2003, AXXX has the potential for requiring higher statutory reserves. So, what might fixed ULs with secondary guarantees look like in the post-AXXX world? Lets see.
Secondary guarantees have been a fixture in many fixed ULs via provisions ensuring the UL will not lapse for a set number of years, provided actual cumulative premiums paid exceed a cumulative no-lapse premium target. Most such guarantees today run for periods of up to a lifetime.
The long lifetime options now available have spawned new issues as a result of the Valuation of Life Insurance Policies Model Regulation, or Guideline Triple-X, adopted by National Association of Insurance Commissioners, Kansas City, Mo., in 1999. Although Triple-Xs statutory reserve methodology for term insurance was well defined, uncertainty remained regarding secondary guarantees on fixed ULs. Now, fixed ULs issued after January 1, 2003, are subject to AXXX.
Whether a fixed UL with secondary guarantee remains in force (when actual policy value or cash surrender value is negative) is contingent upon the policyholder having met a defined set of funding requirements irrespective of the base UL account value. The requirements typically are one of the following types:
1) Specified Premium. To remain in force, ULs that define the secondary guarantee in terms of payment of specified premiums usually require actual cumulative premiums paid to be at least as large as the cumulative no-lapse specified premiums. Some companies define accumulation of both actual and target premiums to reflect interest (often at a 4%-5% annual rate).
2) Shadow Account. Shadow account designs use an account value mechanism to determine whether the secondary guarantee is in force. As long as the shadow account value is positive, the UL will not lapse, even if the base plans actual policy value is negative.
This auxiliary account often operates in a similar manner to the base ULs account value. It is calculated based on the actual amount and timing of the premiums. However, the load structure, cost of insurance charges and interest-crediting rate are all fixed at issue and are often different from comparable components on the base UL. The shadow account is normally used only to determine whether the secondary guarantee is in force; policyholders typically have no access to its funds.
Some insurers offer a catch-up provision with the above designs. Such provisions permit policyholders to re-engage the secondary guarantee after previously failing to meet the secondary guarantee criteria. In the case of specified premium ULs, owners exercise the catch-up by paying cumulative past premiums (plus interest penalty). In shadow account designs, owners pay sufficient premium to turn the shadow account positive.
Because the nature of the secondary guarantee is essentially the same under either structure, what factors might carriers consider when designing a secondary guarantee?
Premium Levels. Consumers might be indifferent to the choice of structure because the essential guarantee is the same for each design. However, the AXXX methodology may produce lower reserves for one versus the other, depending on shadow account parameters. A shadow account design also allows greater flexibility to clients and reps.
Under either design, it is frequently difficult to offer competitive premiums under all funding scenarios. For example, combinations of shadow account parameters that generate competitive secondary guarantee level premiums may create relatively uncompetitive limited pay secondary guarantee premiums.
Catch-Up Provisions. Consumer-friendly catch-up provisions may reduce market conduct risk as they permit benefit continuation in certain situations (as when the premium arrives a few days late). Limiting these provisions to three to five years can mitigate mortality anti-selection and interest rate risks.
Specified Premium Interest Accumulation Rate. Without interest rate recognition in the cumulative premium test for specified premium ULs, policyholders typically could not fund the guarantee with a single premium (equivalent to the sum of specified premiums), because the single premium could violate IRC 7702 limits. Judicious selection of an interest accumulation rate can avoid overly competitive limited pay scenarios.
Systems Complexities. “Dial-a-period” and “dial-a-premium” functionality can be critical for illustration systems in the UL secondary guarantee market. The guarantees impact administrative, pricing and valuation systems, as well. From a systems perspective, shadow accounts are generally considered more challenging.
Reinsurance. In addition to reinsuring the mortality risk on the secondary guarantee, direct carriers often look to reinsurers for financial reinsurance on the higher level of reserves required under Triple-X and AXXX. But availability of reinsurance for secondary guarantees currently appears to be somewhat limited. When availability returns, ceding a portion of the risk may make companies somewhat indifferent to the choice of design structure.
Pricing Timeline. While pricing specified premium designs can be relatively straightforward, shadow accounts have complexities that can increase the time required to price the product. Even if all systems were capable of handling shadow account complexities, determining shadow account parameters may require a process similar to designing the base plan.
These factors cover just a few of the issues to consider in developing UL secondary guarantee plans. The market will undoubtedly continue to evolve, as carriers carefully weigh options under existing and new structures.
Timothy C. Pfeifer, FSA, MAAA, is a principal, and Nancy W. Winings, FSA, MAAA, is a consulting actuary for Milliman USA in Chicago. Their respective e-mail addresses: firstname.lastname@example.org and email@example.com.
Reproduced from National Underwriter Life & Health/Financial Services Edition, July 21, 2003. Copyright 2003 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.