Sheryl J. Moore’s NAIC Comment on IUL Illustrated Rates
November 5, 2014 by Sheryl J. Moore
September 28, 2014
National Association of Insurance Commissioners
Mike Boerner, Chair of Life Actuarial Task Force
Texas Department of Insurance
Austin, TX 78701
Moore Market Intelligence
Sheryl J. Moore
5148 E. University Avenue
Pleasant Hill, IA 50327
RE: Actuarial Guideline on Illustrations for Indexed Life Insurance Policies
Dear Chair Boerner:
Before providing my commentary on IUL illustrated rates, I believe it is prudent to understand my perspective on the matter-at-hand. I am convinced that I can provide an invaluable perspective on this matter, which is unmatched by any other individual. My name is Sheryl J. Moore, and I am president and CEO of a consulting firm that works exclusively with indexed life and indexed annuity products- Moore Market Intelligence. The primary purpose of this business is to educate people on indexed products- their filing, administration, research, development, marketing, training, regulation, sales, and more. While I do provide product development, market research, and competitive intelligence services in order to maintain my profitability, I have always charged a flat fee of all of my clients, to ensure that I can continue my mission of “not endorsing any company or product.”
I also serve as the president and CEO of an independent market research firm which initially focused exclusively on indexed products, but has since expanded to include all types of fixed and indexed life insurance and annuity products- Wink, Inc. Through this market research firm, my staff and I track every single indexed insurance product, their features, rates, marketing, and sales. The LifeSpecs tool at LookToWink.com has served as the life insurance industry’s only source of product and rate information on indexed life for more than five years. Our firm has conducted a “Monthly IUL Rate Survey,” which has been distributed to nearly every carrier in the indexed life industry for more than a decade. Our Wink’s Sales & Market Report has been the life insurance industry’s #1 resource of indexed insurance product sales since 1997; segmenting sales by product, company, crediting method, index, distribution, surrender charge period, and more.
You’ll please forgive me if some of my commentary is elementary to you and other LATF members, as I want for my comment to serve as an educational tool for regulators and stakeholders who are less familiar with indexed life insurance. Thank you for your consideration.
I began my career in life insurance in 1999, working for a newly-formed insurance company named ‘AmerUs Life’ (which was a merger of Central Life and American Mutual). Although I had no prior experience in the insurance industry, or any knowledge of indexed products, I learned quickly about the indexed market due to AmerUs’ focus on indexed life and indexed annuities. Initially, I was responsible for policy administration: working with legacy systems, corresponding with inforce contract owners, and frequently assisting orphaned policyholders. It is during this time that I became intimately familiar with the class action lawsuits that plagued nearly all sellers of interest-sensitive life insurance products that were marketed in the 1980’s. Although equally exposed to “vanishing premium” cases on the whole life side, it is the Universal Life (UL) purchasers that I spoke to most-frequently. These were often elderly people, on fixed incomes, and recently uninsurable; individuals who had been shown UL illustrations at then-current rates of 12.00% at the UL policy’s point-of-sale, but later had their inforce renewal rates dropped to the minimum guaranteed rates of 4.00%. I am certain that all interested parties in this matter can understand the grand disparity between projected and realized outcomes on these policies.
As I continued to advance my career at AmerUs, I became responsible for the development of the illustration software that the company’s distribution utilized, in order to create projections of policy values on their UL and indexed life products. [You’ll note that I am not using the acronym of ‘IUL’ to describe indexed life, as AmerUs marketed indexed whole life in addition to indexed UL. Interested parties need to know that indexed whole life products continue to be marketed today, and will be equally impacted by any guidelines that the Life Actuarial Task Force (LATF) develops in regards to illustrated rates on indexed life.] In this role, I was responsible for ensuring that policy values were being projected properly using the company’s software, overseeing the testing of the program, developing software output/input screens, and providing training on the functionality and presentation of company illustrations. This experience allowed me to interact with members of distribution, and to gain perspective on how illustrations were used with prospective indexed life purchasers. It is in this role that I became intimately familiar with the marketing and inner-workings of the indexed life insurance products being offered by my employer. Representing a company that is credited with making variable loans on indexed life a mainstream feature also provided ample opportunities to witness the presentation of cash accumulation sales on indexed life.
I ended my career with AmerUs working for the holding company, AmerUs Group, in a competitive intelligence and product development capacity (supporting subsidiaries such as American Investors Life, AmerUs Life, Bankers Life of New York, Delta Life & Annuity, and Indianapolis Life). Because my employer was focused on remaining a leader in indexed sales, I was given ample resources to ensure AmerUs’ product positioning. In this capacity, I analyzed specimen contracts and policy filings, assisted in rate setting and product development of fixed and indexed life insurance and annuities, performed illustration benchmarking, analyzed products/performance, created collateral materials, and more. While serving in this capacity, I networked with others in similar roles, who were employed with other home offices. I frequently exchanged software, marketing materials, and rates with individuals who performed a function similar to my own, but were employed by my employer’s competitors. It is in this role that I became intimately familiar with the indexed insurance offerings of every company in the indexed life and indexed annuity markets. After some time, I was fielding calls from many companies that were interested in developing their own indexed insurance products. Because AmerUs had a vested interest in growing the indexed life market, I was instructed to share any public information with these individuals, which would assist them in their endeavors developing indexed life. This was done in the spirit of growing the indexed life market, and helping it to attain legitimacy amongst other product lines such as universal life and whole life. One of the last projects I completed at AmerUs was assisting in the development of one of the most competitive no lapse guarantee (NLG) products to ever be offered in the UL market; it just happened to be on an indexed chassis. So you can see, my foundation for understanding the indexed market from a product manufacturing standpoint is strong, varied and expansive.
I left AmerUs to take a position assisting another home office in the development of indexed products. I worked for this company for about a year, prior to staking-out on my own, and incorporating my own company. I realized that if so many different companies had questions for me on indexed products, which I could answer at the drop-of-a-dime, that I should develop an insurance consulting firm. So I did- and Advantage Group Associates, Inc. (d.b.a. Moore Market Intelligence) was formed in 2005. While attempting to establish credibility as an expert on indexed products, as a young twenty-something female in the life insurance industry, I found it prudent to develop an ancillary source of revenue in my product/rate websites (AnnuitySpecs and LifeSpecs). Not long after, I acquired a sales report (formerly conducted by Jack Marrion of Advantage Compendium), which was the exclusive source of indexed products sales at the time of its introduction in 1997. These ancillary services have since been brought under a new company, established via a rebranding process, which is known to the life insurance industry as Wink, Inc.
Since forming my own company in 2005, I have had a multitude of experiences which have given me additional perspective on the matter of indexed life illustrated rates. I have authored a book on indexed life products; developed continuing education courses on indexed insurance products; published over 200 articles on indexed insurance products in more than 20 different newspapers, magazines, and websites; and served as a fact-checking resource to dozens of journalists at more than 50 different media outlets. I have served as an expert witness in class action lawsuits on indexed insurance products. I have actively advocated on behalf of the life insurance and annuity industries for a decade; assisting in drafting legislation that impacts indexed products, via “The Harkin Amendment” and regularly participating in the rule-making process for life insurance and annuity products. I serve as a resource to regulators on issues such as insurance distribution, marketing, product development, and training.
I have also been a licensed life and health insurance agent in the state of Iowa for more than a decade. I have never contracted with a single insurance carrier, and I do not endorse any company or financial product. I have never sold a single contract, in order to ensure my neutrality as an industry expert. And while I do not endorse any company or product, I AM a big fan of indexed insurance products.
I am not willing to risk my premium payments at the expense of potentially unlimited returns. However, I want an opportunity to receive greater excess interest crediting than what is available in traditional fixed insurance products. In short, I am willing to sacrifice some of my downside protection, in order to have a shot at greater excess interest potential. My risk profile is that of a typical indexed insurance client. That being said, I own multiple indexed life insurance policies from several companies.
I believe in indexed annuities and indexed life. My livelihood is not dependent on the products, as I could be doing what I do now for anyone providing fixed or variable products. However, I chose not to because I so strongly believe in the value proposition of indexed products. In fact, this dedication is what motivated me to start my own company working exclusively with indexed life and annuities so long ago. Anyone who has seen me speak in front of a group of insurance agents will attest to the fact that I get excited about these products. To the benefit of my clients, I eat, sleep, breathe, and dream indexed products. Today, I am the foremost authority on indexed life and annuity products, carriers, and the sales of both product lines. I hold ACS, AIRC, AIAA, and ALMI designations, but I do not use them in the course of my business. I am a member of the Association of Insurance Compliance Professionals (AICP), the National Association for Fixed Annuities (NAFA), the National Association of Independent Financial Advisors (NAIFA) and serve as the president of the Society for Annuity Facts and Education (SAFE). I am an indexed advocate solely because of my beliefs about the product line.
Concerns About LATF Discussions on IUL Illustrated Rates
At this point, I would like to point-out that I am not an actuary. I have worked in-tandem with actuaries throughout my 15-year career in the life insurance industry. That being said, I have no interest in actuarial science, despite giving tremendous respect to those that pursue it. I am passionately steadfast in my belief that anyone lacking an FSA does not have the necessary credentials to lead any discussions within LATF. It is my hope that careful consideration of this statement is made in these discussions; I am not merely making reference to myself in this regard.
I also believe that it is worth mentioning my personal feeling that the issue of indexed life illustrated rates is not an issue that is appropriate for LATF to decide. Illustrations, and the rates used in conjunction with these projections of life insurance values are a matter of market conduct. It is perplexing to me that a market conduct issue has landed in the laps of a group of actuaries. Were the motivation for this move tied to the responsibilities of the illustration actuary, I would still argue that this is a market conduct matter, not an actuarial one.
All that being the case, I do have information that is relevant to these discussions, and hope to provide information that can influence LATF’s decisions on indexed life illustrated rates. So, let’s finally get to the matter of illustrated rates on indexed life insurance products.
History of Indexed Life
Indexed life insurance products were not available with the life insurance illustration model regulations were introduced. Transamerica Occidental Life Insurance Company rolled-out the first-ever indexed UL in January of 1997- in response to rising market conditions and the growing popularity of the similarly-structured indexed annuity, introduced just two years prior. Indexed Universal Life’s design was identical to that of traditional UL (which was developed in the 1970’s), but offered the purchaser the ability to earn limited interest based on the performance of a stock market index (without being subject to the losses of the stock market itself).
The indexed life product itself has changed very little since its introduction to the life insurance market. At the end of 1998, seven different life insurance companies offered Indexed Universal Life (IUL) and experienced $64.7 million in indexed sales for the year. Sales eclipsed in 2012 with 48 companies closing a record-breaking $1.8 million in indexed life sales. At the close of 2013, 52 different life insurance companies offered indexed life and secured $1.3 billion in IUL sales that year; and sales for 2014 are projected to be level with the prior year. Given this information, any product development in these indexed products has been driven by competition. One intense area of market evolution since the inception of indexed life is the indexed interest crediting features.
For those less-familiar with the concept of indexed life, this is a fixed life insurance product which credits a minimum guaranteed rate of interest of no less than 0.00%, but credits limited excess interest based on the performance of an outside index. The purchaser is never directly invested in the index. The index-linked interest is able to be offered to the indexed life purchaser via the product manufacturer’s use of call options (and to a lesser degree, put options). The options seller is the individual responsible for making-good on the indexed linked interest that the policyholder receives, via a credit to the product manufacturer. I want to make this very clear, as I have heard misinformation being provided to others on the LATF calls regarding the index-linked portion of indexed life. Because I have also heard quite a bit of misinformation being disseminated about hedging practices on indexed life, I have taken the liberty of requesting that a trusted colleague and FSA, Tim Pfeifer, provide commentary on this matter. (You should receive his comment under separate cover.) Tim is one of several experts that I occasionally refer my retainer clients to, when they are in need of hedging expertise for indexed insurance products. Despite being knowledgeable on hedging for indexed insurance products, I don’t feel it is appropriate for me to discuss pricing matters with LATF given my lack of actuarial credentials. Therefore, I will defer to the experts on indexed insurance pricing regarding these matters.
Evolution of Indexed Life
When considering the historical context of the index-linked interest functionality of indexed life, the initial indexed interest crediting methods offered utilized annual point-to-point or monthly averaging structures for calculating the indexed interest. Today, seven different indexed interest crediting options are used to calculate the indexed interest on these products:
- Annual Point-to-Point
- Daily Averaging
- Inverse Term End Point
- Monthly Averaging
- Monthly Point-to-Point
- Performance Triggered
- Term End Point
These different indexed interest crediting options merely use different mathematical calculations in determining the indexed interest that is credited on indexed insurance products.
The indexed interest crediting features on indexed life insurance products have also changed from initially using only the Standard & Poor’s 500® (S&P 500®) index as a benchmark for indexed interest crediting; where today 15 different stock market, bond, and commodities indices are used:
- 10-Year Constant Maturity Treasury Note
- Barclays Bond Index
- Barclays US Dynamic Balance Index
- Dow Jones Industrial Average
- Dow Jones-USB Commodity Index
- Euro Stoxx 50
- Hang Seng
- MSCI EAFE
- MSCI Emerging Markets
- Russell 2000
- S&P 500
- S&P 500 Global (BMI)
- S&P MidCap 400
- S&P Total Return Index
These different indices merely serve as a myriad of benchmarks, upon which indexed life products can base their limited potential for gains.
The manner in which indexed life products limit their indexed interest has been the last area of tremendous change in the products. Generally, indexed insurance products use one of three “pricing levers” to limit the potential indexed interest which is credited to the policy:
- Participation Rate
- Cap Rate
- Spread Rate
Here, it is important to understand that the indexed interest MUST be limited in some manner on indexed life; this is essential for providing a guaranteed minimum interest rate floor of (no less than) 0.00%. Were the indexed interest potential unlimited, the potential for loss would also need to be unlimited; resulting in a Variable Universal Life (VUL) product, not an indexed life product.
To aid in the understanding of the use of these three pricing levers (often referred to as “moving parts”), I provide the following example where an indexed UL tracks the S&P 500®, with an annual point-to-point crediting method, where the index has experienced an increase of 20%:
- A Participation Rate of 55.00% would afford the policyholder potential indexed crediting of 11.00% (20.00% x 55.00% = 11.00%)
- A Cap Rate of 8.00% would pass-on potential gains of 8.00% to the policyholder (20.00% limited by an 8.00% cap/limit)
- A Spread Rate of 3.00% would leave the policyholder with 17.00% interest credited (20.00% – 3.00% = 17.00%)
Typically, an indexed life product utilizes only one pricing lever on each indexed crediting method offered. Meaning, that although the typical indexed life product has three different indexed crediting method choices, in addition to a fixed crediting method option (which performs similarly to a traditional fixed UL), one method may use a participation rate as the “moving part,” another may use a cap rate, and the third may use a spread rate.
Historically, it was most common to use a participation rate to limit the potential indexed interest credited to the indexed life; where this pricing lever is only utilized on 22.00% of all crediting methods offered on indexed life today. Seventy-six percent of IUL crediting methods today use a cap to limit any indexed interest and the remaining 2.00% of crediting methods use a spread to limit any indexed interest credited.
Given this discussion, it is important to grasp a key element regarding the three main features of indexed interest crediting: crediting method, index, and pricing lever. OVER A LONG PERIOD OF TIME, THESE INDEXED INTEREST CREDITING CHOICES WILL PERFORM SIMILARLY, regardless of crediting method, index, or pricing lever. The options seller prices his options, so that his liability is relative, regardless of these variables. So, why do so many different choices exist today? Purely for the sake of marketing and competition. And while having more than one indexed crediting option available on a product is optimal, it is not crucial. The indexed life purchaser accepts that in any year, they may receive as little as 0.00% interest crediting, but as much as [the cap rate]. The salesperson has communicated that most likely, actual policy performance will be somewhere in between these two extremes. That being said, having several indexed crediting choices available is often desirable, as any given method may outperform another in a single year, despite the fact that they will perform similarly over a long period of time. (i.e. In one year, you may earn 0.00% interest on one indexed interest crediting option, where you may earn 6.00% on another; over time, they will result in similar returns notwithstanding.)
Illustrated Rate Lookback Methods
When indexed life was initially developed, there was confusion on the matter of how best to illustrate the product. There was no precedence for illustrating a cash value life insurance product that received limited excess interest, based on the performance of an outside index. When evaluating Universal Life, this fixed insurance product used the non-guaranteed/current interest crediting rate as the “illustrated rate” which policy values were projected at. This was a methodology that wouldn’t be appropriate for indexed life, as it lent no consideration to the “indexed linked interest” portion of the policy. By contrast, Variable UL used a maximum illustrated rate of 12.00%, but was frequently illustrated at a lesser rate, as determined by securities regulators and Broker/Dealers (B/Ds). Likewise, this wasn’t appropriate for indexed life, as VUL purchasers had unlimited potential for excess interest earnings, in addition to unlimited potential for losses in interest earnings.
As a result of this dilemma, coupled with the lack of guidance in the existing National Association of Insurance Commissioner’s (NAIC’s) life insurance illustration model regulation, insurance companies developed a method for determining illustrated rates on indexed life themselves. The solution that they developed was to use their indexed life product’s current rates (fixed rates, participation rates, cap rates, and spread rates), along with a study of the historical values of the external index (i.e. the S&P 500®) that the crediting method is based upon, in order to determine a hypothetical “illustrated rate.” So, if the indexed life product in question was based upon the performance of the S&P 500® index, and offered a floor of 0.00% in tandem with an annual point-to-point cap of 12.00%, a historical study of the index would be performed assuming a floor of 0.00% for downward performance, and a cap of 12.00% for upward performance. Overall performance would be evaluated over a specified period (i.e. 20 years), and an annualized rate of return would be calculated based on the results. In this example, the resulting illustrated rate would have been calculated using a “20-Year Lookback” illustrated rate lookback method.
Although at the time they were developed, illustrated rate lookback methods seemed a logical solution to the dilemma of indexed life illustrated rates, they have their issues. First, there is no mandatory, standardized lookback method that companies must adhere to in illustrating their indexed products. As a result, the following lookback methods are all in use on indexed life today:
- 20-Year Lookback
- 21-Year Lookback
- 22 – 25-Year Lookback
- 25-Year Lookback
- 28-Year Lookback
- 29-Year Lookback
- 30-Year Lookback
- 25-Year Average
- 30-Year Average
In addition, there are several companies that use a rate chosen at their discretion for their indexed life illustrated rate. Ultimately, there is no reason why nearly a dozen different methods for determining the illustrated rates on indexed life should exist today.
Adding to the confusion is the fact that there is no mandatory standardization on the calculation that companies must use in performing any lookback. Some companies may use averaging in their calculations; others may not. In addition, although two companies may both use a 20-Year Lookback for determining their illustrated rates for indexed life, one company may use the 15th of the month as the date that they capture for historical values, and another company may use the 28th. This merely adds another layer of inconsistency to the matter of indexed life illustrations.
The Arms Race
There has been a tremendous amount of evolution in the indexed crediting options on indexed life over the past 17 years that the product has been available. The primary driver for these changes has been insurance companies’ efforts to offer more “marketable” indexed life products (via higher caps, which result in perceived greater potential for gains, which also result in higher illustrated rates). This has never been truer than since we hit historically-low interest rates. It has been discouraging for me to observe the evolution of these products, where illustrated rates have come to dictate product design. I have seen the following changes occur, all in an effort for the insurance manufacturer to pursue higher illustrated rates on their indexed life products:
- Changing illustrated rate lookback methods (i.e. changing from a 20-Year Lookback to a 35-Year Lookback)
- Changing the dates of the month used in calculating illustrated rate lookback methods (i.e. switching from the 11th of the month, to the 28th of the month)
- Reducing the floor of the product, in an effort to increase participation rates/cap rates (i.e. repricing a product with a 2.00% floor, and reducing the floor to 0.00% in order to afford the same cap, despite an unfavorable interest rate environment)
- Increasing the insurance charges on the product, in an effort to increase participation rates/cap rates (i.e. repricing a product to have greater insurance charges than the previous version of the product, in an effort to afford the same cap, despite an unfavorable interest rate environment)
In the cash value life insurance industry, insurance producers know-well that whichever product has the highest cash values/greatest income from the policy/top death benefits wins the sale (based on the purchaser’s objective for the purchase). Indeed, illustrations can prove useful in the sale of cash value life insurance. However, they are more-often used as a marketing tool, in an “arms race” of sorts. This has particularly hindered the growth of the indexed life market, as many companies have declined to enter the indexed life market due to an inability to compete in the illustrated rates “arms race.” Later, I will challenge stakeholders to consider a proposal which would not only allow the indexed life insurance market to grow and thrive, but also to provide realistic expectations for policy performance to its purchasers.
Sadly, projections of policy values have commoditized life insurance over the past three decades. There are many things that a prospective life insurance purchaser needs to take into consideration in their evaluation of a life insurance purchase: the financial stability of the insurance company selling the product, the effectiveness of the product in meeting their life insurance goals, the product’s performance, and more. Yet, how can the prospective purchaser make an informed decision on which indexed life insurance product is best in meeting their needs today? There is no uniform method for illustrating indexed life policy values; no way to compare two products on an apples-to-apples basis. Even if the salesperson has the ability to manipulate the illustrated rates used in the product manufacturer’s illustration software, often there is controls put in-place to limit how low this rate can be reduced. It can be next to impossible to illustrate several different companies’ products at the same illustrated rate (using the same assumptions); which is truly the best way in which to compare the non-guaranteed/current values on a life insurance illustration. Although the illustrated credited rate on indexed life may never come to fruition, having the ability to compare numerous products’ policy values on a level playing field allows the products’ insurance charges to speak for themselves.
Subsidizing Indexed Interest Rates and Therefore, Illustrated Rates
Being able to compare indexed life products’ non-guaranteed/current illustrated values is all-the-more important when considering that some products have relatively-higher insurance charges, which are effectively subsidizing greater illustrated rates on the contract. Over the past several years, some insurance companies have introduced indexed life products with insurance charges that are comparatively-greater than comparable products, which also offer comparatively-greater participation rates/caps. With such a product, the manufacturer is able to increase their options budget as a result of the increased insurance charges. Having a greater options budget results in greater participation rates/caps, which ultimately results in higher illustrated rates.
Such products are neither good, nor bad; just different. They offer the purchaser the ability to have greater potential for indexed interest than their peers, but they also have greater insurance charges. However, these relatively-greater insurance charges often go unnoticed, until someone reduces the illustrated rate in the insurance company’s software, and the policy seems to “implode” in the non-guaranteed/current values of the projection. The concern here is that the policy values may appear “fine” with an illustrated rate of [10.00%], but how will these contracts actually perform, when indexed credits of 0.00%, 3.00%, 5.50%, etc. are realized? It would be difficult, if not impossible, for a prospective life insurance purchaser to discern this information based on the illustrations provided today.
Changes to Inforce Renewal Rates
Like a traditional fixed UL, the insurance company reserves the right to change the non-guaranteed rates on indexed life products at the end of each indexed interest crediting period (subject to the minimums/maximums filed with the state). For example, annual point-to-point caps can change annually and five-year point-to-point caps can change every five years.
One must realize that the life insurance industry is built-upon the prospective purchaser’s relationship with the life insurance salesperson. The policyholder does not typically make a purchase decision based on a direct relationship with the product manufacturer, and bypass any salesperson. Given this information, insurance companies are careful to foster their relationships with their salespeople; ever-careful to ensure that they continue to give these distributors a reason to do business with them.
As referenced earlier, the UL products sold at 12.00% illustrated rates in the 1980s were forced to reduce their credited rates to the minimum guarantees on the contracts, often 4.00% or 5.00%. These changes in credited rates were unforeseen at the time that the products were introduced. Like UL, some indexed life products have faced reductions in their participation rates and/or caps on inforce policies over the past 17 years. While this is a common practice in the indexed annuity market, it is not nearly as prolific in the indexed life space. Life insurance salespeople must “work harder” for their sales than their indexed annuity brethren. They typically service the contracts much longer than annuity salespeople, to boot. As a result, careful due diligence is performed when evaluating the renewal rate history of the insurance company that the producer is contracted with for indexed life insurance. (No one wants to have that uncomfortable conversation with a client, about why their cap used to be 15.00%, but now it is 13.50%.) In turn, insurance companies are often hesitant to make changes to inforce rates on indexed life insurance.
That aside, it has happened. And how do we account for that on the indexed life insurance illustration, which is provided to the purchaser? Certainly, inforce illustrations can be run at any time, once the policy is issued; and they do give the opportunity to see a product’s projected performance based on the policy charges and rates in effect at the time of the ledger’s production. However, is it likely unforeseen by the prospective life insurance purchaser that in addition to the credited interest likely fluctuating on their indexed life purchase, that their maximum potential for indexed interest may fluctuate once the product is issued as well. If an indexed life insurance policy is illustrated at a rate of 8.00% today, that 8.00% rate is typically assumed to be credited in all years of the illustration. So if the policy’s cap of 12.00% today were to drop to 11.00% the next year, resulting in a lower illustrated rate of 7.00%- that is not taken into consideration in the illustration provided to the prospective purchaser at point-of-sale.
Indexed Life Loan Rates
I would be ignorant if I didn’t take the opportunity to address the rates used in the illustration of loans on indexed life insurance products today. Most assume that indexed life insurance is strictly used as a product chassis for cash accumulation sales. As I mentioned in my personal background, that is not the case. Many indexed ULs have had an extended NLG objective, and the most recent trend is to offer indexed life with a premium-to-endow objective. That being the case, as of 1Q2014 nearly 75% of all indexed life sales were based on cash accumulation. A great deal of life insurance cash accumulation sales illustrate the policyholder taking income from the policy in the sales illustrations.
Historically, insurance agents have advised their clients to take partial withdrawals of the policy’s cash value, until the contract’s cost basis is reached in order to access their policy’s cash values. Once the cost basis threshold has been reached, loans are initiated against the policy’s cash value as a method of accessing funds. Partial withdrawals permanently reduce a policy’s death benefit and cash value. Therefore, the life insurance benefit payable to heirs is forever reduced when withdrawals are initiated and interest earned is thereafter credited on a lesser cash value balance. By contrast, loans reduce the policy’s cash value and death benefit until repaid and also have loan interest that is payable annually on the total loan balance. So, the benefit payable to life insurance heirs can be fully-restored if a loan is repaid, but until such time, a lesser death benefit is payable and interest is earned only on the net cash value.
Indexed life is somewhat unique in its loan offerings, as it offers loan options where the policyholder can continue to receive indexed interest crediting on the monies that are loaned against. (This is akin to non-direct recognition loans on participating whole life.) In order to receive the maximum indexed interest benefit, indexed life illustrations are typically presented showing loans only, as this allows the policy values to be reduced temporarily by the loan amount, but the policyholder continues to receive indexed interest as if there were no loan on the policy.
Initially, this maximum indexed interest crediting and income combination were provided via Variable Loan Interest (VLI) provisions on indexed life. This type of loan rate varies, based on the performance of the Moody’s Corporate Bond Yield Average. Considering the historical Moody’s rate has been around 8.00%, one can see why fixed rate loans (typically averaging around 6.00%) have prevailed in popularity in past decades. Over the past few years, however, Moody’s has remained in the 4.00% – 5.00% range, meaning that variable rate loans have taken favor over fixed rate loans, which have been charging a higher rate of interest. In fact, the average VLI rate today is a mere 4.37%. It is absolutely essential that indexed life stakeholders understand that the VLI rates do change- monthly, in fact. This makes it nearly impossible to predict what VLI rate will be charged on monies taken out of the policy when the agent is illustrating life insurance policy distributions at point-of-sale.
Many companies have scorned the VLI provision on indexed life, citing that both the policy’s credited rate and the loan’s variable rate charged can deviate significantly from what is illustrated at point-of-sale. As a result, some companies with VLI provisions now guarantee that the variable loan rate will never exceed a stated rate of interest (typically 10.00%).
As a result of the negative stigma that has surrounded VLI on indexed life, a new type of loan option has evolved over the past couple of years: participating fixed rate loans. Participating fixed rate loans (sometimes called indexed loans) are like fixed rate loans in that the interest rate charged on the policy loan is fixed (usually at 5.00% – 6.00%), and declared by the insurance company. However, participating fixed rate loans continue to credit indexed interest on the monies that are loaned against, unlike traditional fixed rate loans.
Some have argued that participating fixed rate loans are not sustainable. After all, if Moody’s Corporate Bond Yield Average has historically been around 8.00%, and the rate being charged against the policy cash values is only 5.00%, how is the insurance company going to account for the shortfall of 3.00% interest? Some speculate that non-guaranteed/current caps and participation rates will have to be reduced, in order to compensate for such scenarios.
Ultimately, neither loan option is superior to the other; they are both just means to access policy cash values. There is a great deal of concern with illustrating such loans on indexed life, however. In the past, indexed life has been presented to prospective purchasers as a manner by-which to “make money off of life insurance.” For example, if an indexed life insurance illustration assumes an illustrated credited rate of 8.00%, and a loan rate of 5.00%, the policyholder is effectively receiving a net gain of 3.00% (less policy charges). So, despite the fact that a policy may be “max loaned” in the illustration, the cash values will continue to thrive because of the unlikely scenario that 8.00% interest will always be credited to the policy, and 4.00% loan interest will always be charged. In reality, the policyholder may end-up upside-down on their life insurance when they earn 0.00%, but are charged 10.00% loan interest, in addition to their policy charges. It is for this reason that I suggest to salespeople that if their sale is based on income coming from the contract that they always present an NAIC-compliant illustration showing no loans, in addition to the income scenario illustration. Ultimately, this is a market conduct issue, which could be easily-resolved by effective indexed life illustrated rate regulations. (Other market conduct issues that are related include “equity harvesting” sales and “hyperfunding” sales, which have both been prevalent on indexed life and VUL in the past. Further explanation of both types of sales is available on my website at https://www.winkintel.com/insurance-basics/life-insurance/.)
It has been my practice to advise indexed life salespersons to always accompany their NAIC-compliant illustrations with a supplemental report that illustrates policy values on a “midpoint” basis. The two certainties with indexed life interest crediting are that the policyholder will never receive less than 0.00% indexed interest crediting and that they will not receive greater than the [cap rate]. However, it is absolutely certain that actual interest crediting on the policy is most likely to happen somewhere between these two extremes.
I often tell salespeople and distributors that the values depicted in cash value life insurance illustrations will never come to fruition. When considering the projections in the guaranteed column of the ledger, the policy is unlikely to perform in this manner. Even if the minimum guaranteed interest rate were truly credited in all years, what is the likelihood that the insurance carrier would also increase the charges on the contract to the maximum level in all years? By contrast, what is the chance that the product is going to earn the non-guaranteed/current rate in all years, while the insurance charges remain level on a current basis in all years? Neither scenario is likely.
The logical solution for this problem is to provide a midpoint illustration, which assumes current insurance charges, but a rate between the guaranteed and non-guaranteed/current. Not only do I endorse this practice, but I applaud the great many salespeople that do not go-into a sales presentation without the midpoint illustration. It has even become commonplace for many salespeople to reduce the non-guaranteed/current illustrated rates in the indexed life software (i.e. from 8.00% to 6.00%), and to provide the midpoint illustration as well (which would assume a credited rate between 0.00% and 6.00%).
Issues with Backcasting
Indexed life insurance illustrations generally have a disclaimer to the effect that “Past results are not necessarily indicative of future performance.” I believe that performing a historical study of the index, and basing your indexed life illustrated rates on that study conflicts with the idea behind this disclaimer. If insurance companies didn’t feel that past performance was indicative of future results, why would they illustrate policy values based on past performance? This is problematic and sends the wrong message to all indexed life stakeholders.
I am also concerned when I see hypothetical historical performance presented for indexed life, which assumes current options costs. This is disingenuous, as options costs have varied over time, just as prevailing interest rates have. So, although a company may offer a 12.00% indexed life cap today, ten years ago their options budget may have only afforded them a 10.00% cap. This is not taken into consideration when looking at hypothetical historical performance on indexed insurance products. However, if one is to present a truly valid historical view of hypothetical indexed life performance, they must assume historical options costs in tandem with historical index performance.
Concerns with Both Proposals Before LATF
I first brought the issue of providing additional guidance on indexed life illustrated rates to the NAIC in 2005. I haven’t quit complaining about it since. That being said, I firmly believe that anything worth doing, is worth doing right. I understand that some are trying to work within the current regulatory framework of the life insurance model regulations, but I don’t know if that is possible. This is not something that we should be putting a band-aid on; indexed life is not going away. Likewise, I don’t feel that it is right to make illustration regulations that are unique to indexed life, where they could/should also be applied to other type of life insurance products’ illustrations (i.e. UL or VUL).
For the record, I don’t agree with the proposal set-forth by the American Council of Life Insurers (ACLI). I strongly feel that life insurance companies should not be relying on historical lookbacks when illustrating indexed life. As I have shown, the reliance on historical lookbacks in this market is problematic for several reasons. I have no problems with the other components of the ACLI’s proposal, and in-fact wholly-support the ACLI’s suggestion of using midpoint illustrations.
That being said, I also don’t agree with the proposal put-forth by MetLife, New York Life, Northwestern Mutual, and OneAmerica. In fact, I vehemently disagree with their proposal because it is ridiculous. That being said, I believe that their proposal is based on erroneous information that they were provided in conjunction with indexed life hedging and pricing. Based on this alone, I give the companies the benefit-of-the-doubt that they had good intentions in developing their proposal. They just can’t get it right if their basis for understanding indexed life product pricing is severely flawed.
The Expert’s Opinion
For years, I have lobbied for an alternative to illustrating indexed life, which is based on all of my knowledge and experience. My proposal is simple.
Indexed life should be illustrated at a rate, which is based on the performance of some outside benchmark, which is indicative of prevailing interest rates. Not being an actuary, I don’t feel qualified to suggest which benchmark is used for such a scenario (i.e. 10-Year Treasury?). This illustrated rate should be flexible enough to increase when interest rates are favorable, but also to decline when they are not. The rate should be standardized, used for all indexed life product (regardless of crediting method, index, or pricing lever), and based on a calculation which leaves no ambiguity to product manufacturers. This could be a very positive and simple solution for illustrating indexed insurance products.
This methodology would not be entirely different from the method used to determine the Minimum Guaranteed Interest Rate (MGIR) used in the NAIC’s standard non-forfeiture regulations for fixed and indexed annuities; where the MGIR can fluctuate between 1.00% and 3.00%, based on the performance of the 5-Year Constant Maturity Treasury (CMT) rate. Allowing indexed life to be illustrated at an industry-standard rate, which fluctuates between 5.00% and 8.00%, based on the interest rate environment would solve nearly all of the issues that we have with indexed life illustrations today.
Consider how products would be simplified…how agents would be empowered…how insurance companies would be saved from themselves!
Many have asserted that 5.00% is too low of a rate and that 8.00% is not high enough of a rate. Insurance companies have argued with me, that this methodology is “not fair,” because their products’ caps are higher than their competitors. They have asserted that this proposal is not sound because it doesn’t take different indices or crediting methods into consideration.
Look- the only absolute here is that none of us can predict the future performance of the market. Yes, indexed life purchasers may earn double-digit indexed interest; but they may also earn zero. What they are usually going to get is something in-between. That is a big “in-between,” with indexed life floors generally at 0.00% and caps as high as 17.00% today. An illustrated rate is supposed to be a realistic expectation of what the life insurance purchaser can expect to earn on their policy. Most indexed life companies’ experience data has shown that inforce policies have averaged indexed gains of 6.00% – 7.00% interest annually, over the life of the contracts. This is to be expected, considering the credited rates on fixed UL over the past 17 years that indexed life has been available. That being said, does any reasonable person believe that indexed life policies will earn 10.00% annually, every single year of the contract, when fixed UL is currently averaging credited rates of 4.50% and VUL is generally being illustrated at an 8.00% gross rate? I don’t think so.
The life insurance illustration is provided to the purchaser, and supposed to serve as an educational tool. How else can one conceive how their cash value life insurance policy may perform 40 years into the future? To imagine policy performance without the aid of an illustration is too abstract. Yet, the life insurance industry should learn from the lessons taught by UL products marketed in the 1980s, to “undersell and over-deliver.” I never heard a policyholder complain about receiving an illustration that showed interest crediting of 6.00%, when they actually earned 12.00%. So, who cares how the policy is going to ACTUALLY perform, if the point-of-sale illustration assumed something reasonable or even conservative compared to actual policy performance?
Chair Boerner, I thank you for the opportunity to comment on this matter. I urge you and the other LATF members to evaluate these issues when considering the illustrated rates used on indexed life insurance products. I humbly extend my expertise, and any data that is available to me, in the NAIC’s evaluation of this matter. Please let me know if I can be of further assistance.
Sheryl J. Moore
President and CEO
Moore Market Intelligence