It seems as though every new life insurance or annuity product that comes to market has a “new” feature to guarantee minimum investment gain or to secure the return of premium (ROP). Where did this come from, and where is it going?

Before the mid-1960s, life and annuity policies commonly had guarantees relating to cash values and death benefits. These guarantees generally kicked in only after the policy had been in force long enough to allow the insurer to recoup its acquisition costs. Indeed, it was not unusual for the policies to have no surrender values for many years.

Often this lack of liquidity was a major impediment to sale of the products. Despite that, convincing potential policyholders that it was acceptable to make regular payments on a policy that would yield no surrender values for years was not an insurmountable task. That’s primarily because death benefits and long-term increases in cash values were of greater importance to the buyer than was the ability to recover premiums in the short-term. Therefore, the sales process emphasized the long-term benefits of the life or annuity contract instead of worry about short-term considerations.

But with development of the variable annuity in the mid-1960s, insurers recognized that investment products needed shorter-term guarantees. (As for life insurance, virtually all life policies had death benefits in excess of premiums paid, so short-term concerns about guarantees and ROP were not a consideration–until variable life became reality in the late 1970s.)

In the VA world of the mid-1960s, sales practices still stressed the same long-term objectives that had long been the practice with fixed products. However, concern was growing that a VA owner’s death during a down stock market could seriously erode the owner’s invested savings. History had shown that short-term fluctuations in the stock market could be pronounced.

Insurers decided they needed a way to eliminate worry about this from the minds of VA purchasers. Thus was born the “minimum death benefit”–and with it, a series of technical concerns that persist to this day in products far more complex than VAs. The original minimum death benefit was relatively simple. If the VA owner died while the contract value was lower than the premium paid (minus any withdrawals), the beneficiary would receive at least the ROP.

Usually, this minimum death benefit returned gross premiums, including any sales charges that may have been made at time of original premium payment. (Note: In those days, VAs invariably included a sales charge deducted from premiums–generally at least 8% of premium amount). During this time, VAs were generally only sold in connection with qualified employer-sponsored retirement plans, primarily to school teachers under Section 403(b) of the Internal Revenue Code.

This minimum death benefit remained relatively stable until the early 1980s, when VA sales began to take off and to focus more on consumers than on employer-sponsored retirement plans. Competition grew pronounced, with insurers vying for features that would distinguish their products from others in the same market.

The “enhanced” minimum death benefits emerged as a result. These “stepped up” the minimum death benefit at a periodic interval (usually at the end of the surrender charge period) to the new contract value at that time. Thus, the minimum death benefit was no longer the ROP, but rather the greater of original premium (minus withdrawals) or new contract value.

An interesting historical note is that the first “enhanced” minimum death benefit was offered at no charge to the contract owner. It was designed to prevent sales people from convincing owners to exchange their contracts in order to have a greater minimum death benefit–the current contract value.

Insurers soon began offering even greater enhancements to their minimum death benefits. These included automatic step-ups, regardless of investment experience; minimum guarantees in addition to whatever stock market performance might have provided; and, today, minimum guaranteed retirement benefits and minimum guaranteed withdrawal benefits.

Many of these features have now been transmuted to non-variable contracts. They can be found widely spread throughout most life and annuity policies currently sold.

For insurance product developers, it can easily be “the kiss of death” to fail to recognize the guarantee feature that is, or will be, the hot item for the type of product they are currently bringing to market.

Now comes the hard part: the technical elements of all these “enhanced” features. Almost from the beginning of the first simple ROP minimum death benefit attached to primitive VAs, the technicians have struggled with how to price the features, how to reserve for them, and how to report them to the various regulators.

The original minimum death benefit was treated as an incidental feature. There was no charge attached and only one state required special reserving. Today, many of the newer features can have additional charges included, and there is considerable controversy regarding how and if reserves should be maintained for them.

These product features are so popular in the marketplace that is it a sure thing that they will continue and that new ones will be developed. As usual, many of the technical processes involved will have to be developed along the way, and the product developers hope they will have guessed right in advising clients how to price and reserve for whatever comes in the future.