Pricing Stability of Life Insurance

Barry D. Flagg, CFP, CLU, ChFC

Inventor and Founder of THEInsuranceAdvisor.COM

Last month, we discussed the obvious relevance of pricing competitiveness to overall life insurance product suitability. This month, we discuss the stability of pricing representations which is also a factor of suitability.  After all, pricing that appears competitive at the time of sale/purchase but which cannot be maintained can be worse than a less-competitive product with more stable pricing representations.

For instance, while premiums are often considered the price/cost of a life insurance policy, the premium is not the price/cost of a life insurance policy (unless contractually guaranteed like in term life insurance or guaranteed universal life insurance) any more than the $2,000 contributed to an Individual Retirement Account (IRA) is the cost of the IRA. In both cases, the cost is the sum of what is deducted from the premium/contribution. 

Premiums are instead the funding plan to cover expected cost of insurance charges (COIs), fixed administration expenses (FAEs), cash-value-based “wrap fees” (e.g., VUL M&Es) and premium loads over the expected duration of the policy contract.  In other words, planned premium payments are always a function of the following formula: Premiums = COIs + E – i%. 

Products that appear competitively-priced at the time of sale/purchase but where COIs or expenses are understated, or policy interest/earnings are overstated become under-funded over time and thus risk lapsing without cash value and without paying a death claim.  And because the impact of COI and/or expense increases and/or decreases in policy interest/earnings are often not disclosed, under-funding can go unnoticed for years until it is too late to take corrective measures as a practical matter. 

As such, the stability of COIs, expenses and expected policy interest/earnings is clearly a factor of suitability.  To be considered suitable, policy pricing should be based on the insurer’s historical mortality experience, the historical operating experience of both the insurer and the servicing organization (if applicable), and be based on expected policy interest/earnings that is consistent with historical performance of invested assets underlying policy cash values, as follows:

Are illustrated/expected COIs adequate to fund the insurer’s future claims?

In other words, are the illustrated COIs sufficient to cover future claims based on reasonable mortality assumptions? In addition, the degree to which an insurer can insure a particular risk on their own paper can influence an insurer’s ability to meet future cost projections. Insurers that reinsure a substantial portion of a given risk may be confronted with the need to increase COIs in the event of the dissolution of a reinsurance treaty and/or the failure of the reinsurer. While a product underwritten by an insurer with lower retention is not in and of itself an unsuitable product, products available from insurers with higher retention are considered to have the greatest control over future pricing/costs, and as such, will be considered more suitable than otherwise, all other things being equal. 

Are illustrated/expected policy expenses adequate to meet future administrative and service requirements?

All policies require routine administration and service, and these basic costs are usually insurer expenses. In addition to basic services, wealth accumulation and estate planning products typically require advanced design, due care, and policy implementation services usually provided by the servicing organization and the costs for these services are often met by sales and service loads allocated to those servicing organizations. While there is no guarantee of good service just because a policy may include sales/service loads, the absence of sales/service loads virtually guarantees little or no value-added administration services included.  

Are illustrated/expected policy earnings consistent with historical performance?

Premiums paid in excess of deductions for COIs and policy expenses are credited with some form of interest or earnings based on product type and the allocation of invested assets underlying policy cash values.  While life insurance policy projection systems often allow for a wide range of interest/earnings assumptions, actual policy performance will ultimately be a function of the actual performance of invested assets underlying policy cash values. 

For instance, “fixed products” (i.e., universal life and whole life) are required by regulation as a practical matter to invest assets underlying policy cash values predominantly in high-grade corporate bonds and government backed mortgages.  As such, the policy interest crediting rate for universal life products and the dividend interest crediting rate for whole life products will generally correlate with the 5.0% to 6.0% historical rate of return on high-grade corporate bonds and government backed mortgages over time. 

Likewise, “variable products” (i.e., variable universal life and variable life) generally invest policy cash values in a wide variety of mutual‑fund‑like separate accounts, and thus the policy earnings rate for variable products will generally correlate with rate of return for the assets classes into which cash values are allocated (e.g., 10% for aggressively-allocated cash values, 8% for moderately-allocated cash values, and 6% for conservatively-allocated cash values).  

While stable pricing does not guarantee future policy performance, the stability of pricing and performance representations is clearly a factor of suitability. Should expected COI charges be insufficient to fund future death claims, or expected policy expenses be inadequate to cover anticipated services, or actual policy interest/earnings rate be less than expected, then higher premiums will be required, or benefits will need to be reduced, or the policy risks lapsing without value and without paying a death benefit. 

Get beneath the illustration of hypothetical policy values.  Are COIs based on the insurer’s historical mortality experience or some undisclosed mortality improvement? Are policy expenses based on historical operating experience or some undisclosed operating gains? And are expected policy interest/earnings based on historical performance of invested assets underlying policy cash values or something else?  The answers to all these questions determine pricing stability and funding adequacy.