Indexed universal life insurance has been around for 21 years. Through an impressive amount of complexity, it has achieved a nice niche for itself sitting between current assumption and whole life products on the conservative accumulation side and variable products on the moderate/moderate aggressive accumulation side.
The level of complexity built into these products makes them the perfect laboratory for carriers and actuaries to try out new and innovative ideas to bolster returns (on illustrations and hopefully in the real world). For instance, when a product has a cap rate, floor, and participation rate, how hard is it to throw in multipliers and/or bonuses?
If you think about how IULs are created and function, I would argue that we are heading toward the end of its second iteration. The first iteration being all products created prior to the passage of Actuarial Guideline 49–where guidelines were set in place for illustrated rates—and the second iteration being all products since.
Why do I believe we are heading to the end of this iteration? Because Principles Based Reserving is about to crush IRR. While this will be true of other cash accumulation focused products, the complexity of IULs may offer carriers greater flexibility to improve IRRs with the current levers they already have in place on these contracts or new levers they can introduce.
This could lead to IUL eating up even greater market share than it has already. Even with it being one of the most contentious products on the market, not only are IULs here to stay, they are currently buoying our industry. According to LIMRA, in Q2 2018, new annualized premiums from indexed life products increased 14 percent over Q2 2017. Contrast that with, in the same exact quarter, the total annualized premiums from new policies sold only increased two percent. IUL products now account for 64 percent of UL product premiums and, without them, new annualized premiums in Q2 could have looked atrocious.
This news is welcomed for someone who thinks, “The consumer base is getting more comfortable with this product and I can call my clients and talk to them about which one is best for them.”
On the contrary, this news is terrifying for someone who thinks, “This product is incredibly complicated, agents have no idea what they are selling, they are selling them improperly, and clients have no idea what they are buying.”
In my opinion there is some merit to both sides. However, the curveballs that have been hurtling towards us since 2016 are starting to hit the catcher’s mitt. And they may pose the greater threat.
This leads us right back to Principles Based Reserving. PBR brings one of the most significant changes in the laws regarding how insurers are supposed to hold reserves for claims purposes. In addition to new reserve requirements, for every product to adhere to PBR it must adopt the most current Commissioners Standard Ordinary (CSO) Mortality tables. Every product is required to adhere to this standard by January 1, 2020.
Without getting too into the weeds, this regulation should usher in decreases in premiums for most products with an increase in secondary guarantee premiums. However, the largest impact it will have on product performance will be in driving down cash values.
A quick refresher on cash values. To determine whether a policy qualifies as life insurance and not a Modified Endowment Contract (MEC), the contract cannot accept more premiums in the first seven years than what would be required to have the policy paid-up over that time, hence why we have the 7-Pay Test. This is over simplified, but it is enough for this conversation.
In many scenarios, PBR will allow carriers to carry lower reserves on products than they are currently required to (which would lead to a decrease in premiums) and the longer life expectancy on the new CSO tables means that mortality costs should also see a decrease.
So, with the expectation that premiums are decreasing, it stands to reason that less premiums would be required to pay up a policy in seven years.
This is what we, as an industry, have been expecting. It took carriers longer to put out PBR compliant products than we anticipated, but we are finally seeing them rear their faces as time ticks down. One carrier just updated their line of products and for a 55-year-old preferred client the maximum non-MEC premium dropped by 21 percent and the IRR over 30 years dropped by .92 percent sitting in the same exact account.
This decrease in performance is due to the forced premium reductions from lowered reserve requirements and mortality (think 7-pay premium) while operational costs to the carriers did not decrease. This leaves a greater percentage of a reduced premium being consumed by charges than had been before, so less funds are allocated to the investment account.
One positive about the carrier mentioned above is that their new PBR compliant IUL contract does seem to be more transparent than their current line. If this is a trend that other carriers follow, I would consider this a positive consequence.
So, what does the third iteration of IUL look like?
As of right now it is unclear. Carriers are not going to like the numbers that we are currently seeing come out of compliant products. My guess is that it will include greater levering of charges to boost performance in later years. How this could be accomplished is up to the brilliant minds of actuaries.
I would not be surprised if we started seeing more term riders available on accumulation focused products as a means of increasing the amount of premium a contract can take without becoming a MEC.
Then there are “wild,” out of the box ideas that spring up that no one seems to predict. These are generally thought up by one carrier and then copied by others. When we start seeing new definitions in the contract language, they will likely be stemming from these sorts of ideas.
Some or all of these will usher in the third iteration.
A greater issue in all this—that I have not been able to get a good answer to yet—is, “Where are all of these compliant products?”
As I alluded to earlier, there are very few contracts out that are PBR compliant. As of this writing only 31 out of 277, or just over 11 percent, of the products that LifeTrends tracks are PBR compliant. Some carriers are currently putting out new products that are not PBR compliant.
If you are following along, the line of reason goes: If all products need to comply by January 1, 2020, and only a few products currently comply, and state insurance departments are not known for their efficient processes in approving products, then we are fifteen months out with hundreds of products requiring approval...
What happens when August, 2019, rolls around and states have hundreds of new products submitted and awaiting approval by December 31? Could we see a massive logjam for product approvals? Could we start off the era of PBR compliance with a very limited set of products? Could an extension be filed to alleviate the increased load the state insurance departments will receive?
I do not know the answers to any of these questions, but each question is deeply concerning to me and everyone I have discussed them with.
With such an uncertain future I am confident that now is a great time to suggest to advisors that if a client is looking to over-fund a policy as much as possible for cash value growth, but they have been putting it off, now is the time to get off the sideline. The current product lines allow for far greater funding and with (likely) less levers than the next generation of products. Not just IULs, every product that is developed for cash growth should look far better today than it will a year from now.
Now that I have brought you up to speed with my concerns, I would like to end on a lighter note.
On its face the third iteration of IULs will be like every other product line—neither good nor bad. It will be incumbent on us, as always, to make sure that we understand how each product works to provide the best possible advice to our clients.
Lastly, I think it is always important to remember this: While we all have a rough idea of what IRRs we are looking for in a product and how these products work, most clients do not. While a product may not be attractive to us, it might look great to them. It might fit into their plan perfectly and, if it is sold properly, it should allow them to put their heads on their pillows each night for a very long time. So, let’s strap in and get ready for a wild year as the PBR deadline looms. There are always fireworks at midnight on New Year’s Eve. Let’s hope the fireworks at 12:01AM on January 1, 2020, are all in the sky.
joined Algren Associates in May of 2016. His role includes consulting and case design with a focus on strategies and options for high net worth, business, and estate planning clients. He was an agent with Prudential for four years prior to serving as the internal case specialist for a top advisor at MassMutual. Unger currently serves as the Young Professionals Chairperson for the New York City chapter of the Society for Financial Services Professionals. Unger can be reached at Algren Associates, 212 West 35th Street, 5th Floor, New York, NY 10001. Telephone: 212-594-9889 x223. Email: [email protected]