What better insurance vehicle could offer upside equity return potential while promising a floor on death benefit protection? Variable universal life policies incorporating a guaranteed minimum death benefit could fit the bill.
Historically, VULs with GMDBs have been thought to be weaker than universal life policies with secondary guarantees and equity-indexed life guarantees, but that trend seems to be reversing slowly. Lately, there seems to be more competitive GMDBs emerging in the market.
UL contracts are generally long-term in nature, with some contracts expected to remain in force for 20, 30, even 40 years. This long-term chassis, particularly with a level pay premium pattern, would seemingly be well suited to the potentially volatile but generally long-run superior performance of a VUL contract.
In the not too distant past, a common approach in developing premiums for VULs with a GMDB feature was to utilize a low-growth assumption for the account value, such as 2% to 4%. Here, the aim was to solve for the level-pay premium that would allow the account value to last to the end of the GMDB period (e.g., age 85).
This low-growth assumption seems very conservative, even relative to moderate historical long-term equity market return experience. This makes it very challenging to develop competitive premiums, as compared to recent ULSG levels. Still, this method was used for a number of reasons, including simplicity, conservatism and the lack of focus on competitive long-term GMDBs in the VUL market.
But now VULs are taking a page from the variable annuity playbook.
It is well known that product guarantees have become a cornerstone in the VA market, particularly in the last several years. Managing the risk associated with offering these guarantees has therefore become a core competency of many companies. Leveraging these capabilities can help insurers incorporate more competitive GMDBs into their VUL products, too.
Here are some applicable strategies:
Dynamic hedging: this is used in some form by the vast majority of VA writers. Since many of the significant VUL issuers also offer VAs, these insurers could conceivably leverage their hedging expertise to help manage the VUL GMDB risk. Hedging programs generally benefit from diversification, so combining VUL GMDB hedging with existing VA hedging programs may improve overall hedge results.
Asset allocation requirements: these requirements are a key risk reduction tool used by VA companies. Not allowing contract holders to allocate 100% of account value to highly aggressive subaccounts significantly reduces the risk and hedge cost for the guarantee. Asset allocation requirements take many forms, from limiting the investment percentage that may be allocated to aggressive subaccounts, to requiring the entire account value to be invested in 3 to 5 pre-set allocation models.
Target maturity date funds: Sometimes described as funds for auto-pilot investing, the target maturity date funds start with a higher equity allocation initially and drift toward a lower equity allocation as the target date approaches. This shift from more to less aggressive asset allocation could fit well with a GMDB on a VUL product.
Another consideration, for adding GMDBs to VULs, is the potential for reserve relief. Perceived excess reserves on life insurance products, particularly those in UL secondary guarantee products, has been a hot topic in the market for some time. The development of a principles-based approach for reserving is coming down the road to potentially address this and other issues.
Currently, VULs with GMDBs have their own special reserving requirements. Actuarial Guideline 37 addresses the reserving issues for GMDBs, including a discussion of the possibility of holding less than the formulaic reserve.
This means that a first and necessary step would be to provide, to the state of domicile insurance department, evidence of satisfactory documentation on why such reserves would be redundant. Developing a solid product, implementing asset allocation requirements and/or target date funds, and developing an effective ongoing hedge program may lend a level of support to this argument.
In conclusion, insurers face many challenges concerning how to allocate resources among product lines. For many, VUL efforts have been a low priority. But as demand for VUL with GMDBs increases, more carriers will step up and develop competitive products. Equity market volatility will never go away, but those choosing to follow the VA market’s lead may see increased VUL sales as a result.
Another recent development is the addition of guaranteed minimum withdrawal riders on VULs. Charges for these GMWB riders could be assessed at the rider activation date and beyond, instead of starting the charge in the first policy year. If risk management programs are in place for GMDB risks, then adding and managing GMWBs on VUL products would seem to be a natural.
The VA market has become a guarantees market and companies have obtained the expertise to manage these guarantees. The VUL market should be leveraging these capabilities to bring stronger guarantees to the VUL space. Companies taking the lead here should be well positioned for success.
Dale Visser, FSA, MAAA, is a consulting actuary and Tim Hill, FSA, MAAA, is a consulting actuary and principal, in the Chicago office of Milliman, Inc. Their respective e-mail addresses are: firstname.lastname@example.org and email@example.com