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.
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.