Challenge to life companies

[Robert L. Barney]

One of the problems I have always had with actuaries is that they speak in code. Remember that most of the people reading these postings do not know your code, and so it would be quite helpful if you could write accordingly.

It is my understanding that the "non-forfeiture" rules have to do with how big the reserves in the policy get, in relation to the face amount. For example, if the reserves (CSV's for clarification; I know, CSV's are always less than the reserves) become 25% of the face amount, the product must have cash values at which point lapse ratios become a much smaller benefit to the life company.

This is why the longer the level period on a policy, the lower the maximum issue age. In fact some companies, in some states, have smaller issue ages (particularly for male smokers), than they do in other states. This is to ensure the reserves do not pass the speed limit permitted by the non-forfeiture law.

Before I continue to comment this - could some actuary please confirm or correct my understanding to this point.

Be careful - I don't talk in actuarial code.

I want to make sure that if I decide to pound away on the regulators, I do so with a correct understanding of the problem that companies are facing.

[JMO Fan]

Sorry about the "actuarialese": I'll try to do better. Here are a few basics:

Nonforfeiture is about cash surrender values (not reserves). Nonforfeiture laws are to help people who pay for permanent life insurance. Because they pay level premiums, they pay more at younger ages than for term insurance, so the insurer can hold more in reserve for future deaths.

If a person has paid a lot of level premiums, then stops, nonforfeiture law says they should get something for the extra premium. They should not forfeit what they've built up. So they get reduced paid-up (RPU) or extended term insurance (ETI).

Nonforfeiture law makes it so people don't forfeit all their insurance when they stop paying premiums. Current nonforfeiture law requires the insurer to offer them cash if they don't want RPU or ETI. Cash surrender values are required as an available substitute for the nonforfeiture options, RPU or ETI.

It is true that the insurer can afford to pay the cash (and offer RPU/ETI) because they have built up the reserves. That's why the reserves can't be less than the cash values. But the reserves are (generally speaking) built up by different formulas from cash values.

On UL and term, current law makes reserves much more than required cash values. That's hard on insurance company profits. Principles-based reserves are supposed to help reduce reserves to a more reasonable level.

Long level periods for term insurance make them look similar to whole life. If it is too close to whole life, the nonforfeiture law (often called SNFL, pronounced "sniffle") forces the level-premium term to offer cash values (as well as RPU or ETI). The trigger is when the SNFL formula makes the minimum cash value $25 or more per $1,000 of insurance (i.e., 2.5% of face).

There are some proposals to lessen the SNFL requirements, and possibly allow 0 cash value if RPU or ETI is offered. It is unclear whether they can follow the apparent success of principles-based reserves, but that is their best hope. Traditional companies (e.g., ACLI biggies) don't want SNFL to change -- they don't want their successful boat rocked in any way.

Please let me know if this explanation helps.

[actuary_guy]

That was my point as you said that "Principles-based reserves are supposed to help reduce reserves to a more reasonable level."

You mentioned that "Traditional companies (e.g., ACLI biggies) don't want SNFL to change -- they don't want their successful boat rocked in any way."

I've also heard the arguement that if a product such as 40-year term with no Nonforfeiture values were created this would essentially be considered too close to a whole-life term with no nonforfeiture values and this could jeopardize the tax-free inside buildup of UL.

In other words you've solved the problem for term but you destroy the appeal of UL by rattling the IRS's chain.

Any thoughts?

[JMO Fan]

Jeopardy for the inside build-up killed the last 0-CV proposal a few years ago. Now it isn't as clear that the IRS will care. It might depend on the result of principles-based reserving on tax reserves.

[actuary_guy]

o.k. now I'm confused and you're obviously more knowledge on this than I am.

So my question is if "jeopardy for the inside build-up killed the last 0-CV proposal a few years age." is your statement then.......

How in the world is that not a tax issue? I would think jeopardy for the inside build-up of UL would be a tax issue, yes?

And, Why wouldn't the IRS care about a tax issue? I thought that was everything that they cared about?

[actuary_guy]

JMO,

Another question while I'll agree with you that nonforfeiture effectively puts the kibosh on 40-year term............

Wouldn't writing a ton of 40-year term to 20-25 year olds put a tremendous strain on capital.......say this product has huge potential like Robert believes and company X takes a ton in in premium but the reserve required is more which it will be.........and the company also has to hold deficiency reserves on top of the other reserves. Well.........

The question that comes to mind is: would this be the best use of the company's capital? I understand that letters of credit are out there, but companies are competing for that credit and there is only so much of it out there and I really question as to whether most companies would use it to back 40-year term for 20-25 year olds.

I guess you are saying that if they fix nonforfeiture law via principles based reserves then they will also fix the reserve/deficiency reserve issue.....but it seems like you are brushing this to the side as a minor issue?

Seems like a major issue to me.

[actuary_guy]

Robert Barney,

I have a question: you mentioned that Empire Life illustrated a no-lapse UL with a level premium from age 26 for 39 years to age 65.......and that it was guaranteed not to lapse.

Here's the question: was it GUARANTEED NOT TO LAPSE with those premiums under the CURRENT mortality and interest assumptions?

OR was it GUARANTEED NOT TO LAPSE with those premiums under the GUARANTEED mortality and interest assumptions?

Because if it was guaranteed not to lapse under the current assumptions then I wouldn't find it hard to believe that it could be somewhat competitive to a term product.

However, if it was guaranteed not to lapse under the guaranteed mortality and interest assumptions.....well I just find that very, very hard to believe.

If it was guaranteed not to lapse under the current assumption then comparing it to term insurance with guaranteed premiums is an apples to oranges comparison.......the insurance company can pretty much raise the mortality assumptions and drop the interest rates at their discretion.

It would only be an apples to apples comparison if the premium in the UL were guaranteed to age 65 under guaranteed mortality and interest assumptions.

Also the companies that you are getting guaranteed UL projections from on age to retirement, I would also be sure that they are guaranteed based on guaranteed assumptions not current.

Wow I said guaranteed and current alot.

[JMO Fan]

Originally Posted by actuary_guy

o.k. now I'm confused and you're obviously more knowledge on this than I am.

So my question is if "jeopardy for the inside build-up killed the last 0-CV proposal a few years age." is your statement then.......

How in the world is that not a tax issue? I would think jeopardy for the inside build-up of UL would be a tax issue, yes?

And, Why wouldn't the IRS care about a tax issue? I thought that was everything that they cared about?

Years ago, tax law experts felt the IRS would assault the inside build-up if no cash values were required. Changes in the IRS have made current experts less concerned, but wary. The IRS might have a tough battle convincing Congress to tax inside build-up, which has been tax-sheltered forever, because it has become politically incorrect to create new taxes.

[JMO Fan]

Originally Posted by actuary_guy

I guess you are saying that if they fix nonforfeiture law via principles based reserves then they will also fix the reserve/deficiency reserve issue.....but it seems like you are brushing this to the side as a minor issue?

Seems like a major issue to me.

The emphasis of this thread was cash values, but the reserve issue is the major issue to be resolved by principles-based reserves (PBR). Many agree that recent changes in reserve rules (e.g., XXX and AXXX) produce excessive reserves. PBR is expected to eliminate excessive reserves.

If principles can be used to reduce statutory reserves, some feel that similar logic can reduce statutory cash value requirements. Most regulators know that CVs cost extra premium. That doesn't seem fair to those who just want death benefits, so it makes sense to minimize the CV requirements.

[JMO Fan]

I don't know Empire Life's UL specifically, but many current UL use a "shadow account" for no-lapse guarantees. This means the policy has two sets of mortality/expense and interest guarantees. Traditional guarantees, e.g., 1980 CSO & 3% interest, are used to accumulate account values. The second set of guarantees, with lower mortality and higher interest, is used to accumulate premiums (for no-lapse purposes only, not cash values) in the shadow account. The second set of guarantees (shadow account) is often more conservative than current cash value crediting, so it is expected that accumulated premiums will keep the policy going if the current basis doesn't change. If interest rates drop, and current CV goes to 0, the policy still won't lapse if the shadow account is positive.

Even so, 0-CV UL is usually significantly more expensive than level-premium 0-CV term would be. UL requires a lot of administrative costs (and reserves) that simply aren't needed for term insurance. But if 0-CV term isn't available, no-lapse UL might be about the only way to get level premiums without cash values, which is cheaper than level-premium WL or UL with minimum cash values.