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Keeping universal life products attractive

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When I started my career back in 1982, universal life insurance was the new kid on the block among very well-established life products — mainly traditional whole life and term insurance.

In 1979, E.F. Hutton Life designed and marketed what is acknowledged as the first successful UL product. It was not until certain changes were made to the Standard Valuation Law (SVL) in the late 1970s that UL began its path to displacing traditional life products as the major selling product in the industry. The Deficit Reduction Act of 1984 (DEFRA) helped clarify a number of unanswered tax issues that had originally prevented UL from taking off. The next several years saw universal life plans continue to proliferate and eventually dominate the market throughout the 1980s.

Over the past three decades, universal life products have evolved with changes in the investment environment. By design, universal life products were built in a high interest rate environment. In today’s low interest rate environment, insurers face the challenge of reinventing universal life insurance products for the new millennium, and many have come up with interesting strategies to do so.

Universal life design and interest rate crediting

While traditional life insurance was somewhat of a black box to the purchaser, universal life took an “unbundled” approach and was transparent to the policyholder with respect to policy expense charges, cost of insurance charges, policy level activity and interest rate credits to name a few.

When UL products became widely available, in the early 1980s, market interest rates were very high. The prime rate hit an all-time high of 21.5 percent on December 19, 1980, and this provided a solid launching point for universal life sales, as UL credited a market-like interest rate in the double digits. In addition to the unbundled aspect of universal life and other non-variable interest sensitive life plans of the day, the market interest rate credited to many of these plans was a big driver of UL’s success. Traditional life plans, both participating (i.e., dividend paying) and non-participating were not able to keep up with the values that were being generated by UL illustrations. Quite a number of UL sales of that era came from insured individuals exchanging their traditional whole life plans for the newer interest-sensitive life plans.

Yet, the interest rates illustrated on many of the universal life plans led to the plans’ downfall in the 1990s. Many companies had illustrated double-digit credited interest rates in their UL illustrations, assuming that level of credited interest rates would last forever. As market interest rates began their long path downward, many insurers realized they had to start crediting lower interest rates than originally illustrated.

As a result, there was a spate of class action litigation in the 1990s relating to interest-sensitive life insurance illustration performance. Insurance companies began to rethink their universal life product lines, especially with respect to interest rates that were projected on illustrations. Eventually, the Life Insurance Illustrations Model Regulation was promulgated to eliminate what some in the market had deemed misleading illustrations. 

Universal life in the new millennium

According to data from LIMRA International, universal life has seen a comeback of sorts in the 2000s, as market share as a percentage of life insurance premium has grown from 27 percent in 2002 to 42 percent in 2011. In the early part of the decade, quite a bit of the growth was due to the significant stock market corrections that occurred, which led to a flight from the perceived riskiness of variable products. There was also a flight to quality caused by the uncertainty of a post-9/11 financial market.

See also: 2012: A mixed bag for life insurance sales

Quite a bit of the growth in UL in the 2000s also came from changes in product design and the introduction of new products, including fixed indexed universal life (FIUL), that helped to mitigate the downside risk often associated with products like variable life.

While FIUL products, like variable products, shift the burden of determining the interest rate credited from the insurance company to the financial markets, there are still significant issues that exist for the FIUL market, and for the UL market in general, as a result of the current low interest rate environment.

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Strategies for universal life products in the current market

Today, life insurance companies have had to grapple with the issue of how to develop products that will provide the insured with a solid value proposition while performing in a low interest rate market. When compared with competing life insurance products, UL holds the dominant market share with respect to premiums. Yet, that share could erode in a bull market (as variable life sales increase) or in a volatile/apprehensive market (as insureds move to whole life and term products in a flight to quality).

FIUL products offer the potential for upward appreciation while limiting the downside risk often associated with variable products.

Secondary guarantee UL products, commonly referred to as shadow account UL, are a product line where the emphasis is on securing insurance protection over a prolonged period of time rather than trying to accumulate significant cash values. The insurance protection is guaranteed to stay in force as long as the underlying “shadow” account is positive. Premiums are lower than a normal UL product and, at older ages, are attractive enough to lure buyers, given that term products are not available or not feasible at those older ages. While there are several products on the market that provide guaranteed insurance coverage all the way to contract maturity, the shadow account works in the same way as a normal UL accumulation fund, except that the credits and charges assessed to the shadow account can be quite a bit different in scale and size than the normal UL accumulation fund. As long as the shadow account is positive, the policy will stay in force, even if the cash values of the normal UL accumulation fund turn and stay negative.

While most, if not all, life insurance companies have jumped on the shadow account wagon, the amount of capital reserve needed to support a shadow account UL product has given several life insurance companies pause. Another risk for the insurance company selling shadow account products is lapse risk. Most shadow account UL products are lapse supported, meaning that more lapses mean more profit for the insurance company. So, it is important for the insurance company that manufactures and sells shadow account UL products to be very judicious in its estimate of future lapse rates during the pricing process. An additional worry for the insurance company is the older age risk that comes when a disproportionate number of policies issued are to older age individuals. 

Though there are numerous risks for the insurance company in the shadow account UL market, as well as capital intensiveness and limited profitability, these products have been a hit with the consumer looking to maintain life insurance protection for a long time frame at a reasonable price.

Insurance companies continue to try and find ways to make cash accumulation UL both appealing to the general life insurance-buying public and profitable to sell. These include managing the other sources of profit, such as mortality, expense and surrender, even more closely than before. Becoming more effective at overall insurance expense control has been one way companies have tried to cope. Others have used increased policy charges to allow for the crediting of higher rates. Features, such as new riders (long-term care, for example), have also been a way to make UL more attractive in light of a low interest rate scenario. Also, market value-adjusted products have been introduced.

Whatever method is in use, insurance company creativity continues to show through as one of the strong points of our industry. Inevitably, cash accumulation UL will come back into the forefront one day when interest rates begin their inevitable climb upwards. Until then, companies will continue to exercise their vast creativity to continue selling these products and provide value for their clientele.

For more on universal life, see:

Answers to the top IUL questions

Hybrid products: Just right for value-minded consumers

Indexed GUL: The all-purpose solution