Lapse rates on ordinary life insurance products, which were between 5.3 percent and 5.9 percent in 2012-2015, represent the lowest rates in nearly 20 years, according to a new report.
An A.M. Best Special Report, “Anemic Yields Put Spotlight on Retention,” reveals that ordinary life persistency has been relatively steady, fluctuating between 81.1 percent and 86.5 percent from 1997 to 2016, a trend that correlates with the U.S. unemployment rate. The last two years have seen the highest persistency rates in nearly 20 years, around 86 percent.
Lapse and persistency rates remain important issues for U.S. life/annuity (L/A) insurers, as it can result in increased pressure on revenue and reduced profitability. While life insurers have taken initiatives to reduce lapse rates — the percentage of in-force contracts that insurers terminate due to nonpayment of premium, insufficient cash values, or full surrenders — policy lapses vary with enterprise-wide risk management (ERM) strategies and macroeconomic factors.
The A.M. Best report also notes that new policy sales can be relatively costly and time-consuming. As policies remain in force, as measured by the persistency rate, policy acquisition costs decline, leading to an increase in profitability.
Total ordinary life direct premiums written (DPW) has been on increasing trend since 2009, with a slight decline in 2013, the report notes. DPW reached $140.0 billion in 2015, the highest level since 2008.
However, the composition of total life premiums written has shifted. Renewal premiums, which accounted for 65.3 percent of ordinary life DPW in 2005, now account for 72.6 percent in 2015.
During this shift, single premium DPW declined to $18.0 billion in 2009 from $40.3 billion in 2007. Allocations of single premium ordinary life policies as a percentage of total life premiums have also declined, to 14.0 percent of DPW in 2015 compared with a high of 27.7 percent in 2007.
A.M. Best views more favorably those companies that have an increased percentage of higher creditworthy and less risky products, which can positively impact business profile. Unless it is a lapse-supported product, persistency generally benefits a company’s profitability.
However, even lapse-supported products need to persist for a good number of years to become profitable, the report states. Higher profit margins can be attained on renewal business, since acquisition expenses are recorded at the time of sale.
Operating performance is also impacted by low interest rates, which may cause spread compression on interest-sensitive life products, such as universal life. Balance sheet strength is also impacted by strong persistency, as profitability from renewal business contributes to capital and surplus.