FI Financial

Group of Companies

Today's life insurance industry

I have been asked to speak to you today about understanding Universal Life.

That is a pretty tall order but in the context of the new market conduct and sales illustration disclosure requirements it is an extremely important topic so I will do my best.

It might be useful to first take a minute and look at the environment in which today' products are being developed and sold.

Today's life insurance industry and, in fact, the entire financial services industry has changed very quickly and dramatically over the last couple of decades.

Constant and rapid changes in the economy have become the norm. In the last couple of decades we have seen both record high and record low interest rates and it is anyone's guess what lies ahead.

That economic environment combined with a changing regulatory environment, now has us competing for the consumer's dollar not only with other insurers but with virtually every other financial institution as well and it would appear that more changes are still to come as the banks seek approval to sell insurance directly in their branches.

Finally rapidly and ever changing technology has not only seen our traditional rate books replaced by computer illustration systems, but has given companies the capability to design and administer much more complicated products at a very fast rate.

As a result, many of the life insurance products available today have evolved into extremely flexible and sophisticated financial instruments that can be customized not only to meet a consumer's various needs for risk protection, but also to provide a wide range of investment and tax-deferred savings options. This has lead to a great deal of complexity and diversity, not only in the features offered by today's products, but also in the underlying design and pricing.

Actuaries are often quoted as saying that it is the computer illustration systems that are driving the product design process.

The challenge for today's actuary is to develop a product that illustrates well but that leaves the company enough options to reprice or make adjustments later so that they can make money under just about any set of circumstances. Today's product design teams have proven to be very creative with the result being vastly different product features, contractual provisions and differences in the pricing approaches used to support them. This makes the task of trying to compare today's products very difficult, if not impossible, even for the actuaries that design and price them. I know I still get surprises almost every time I do a product comparison.

Combined with all of this today's consumer is more value conscious and will shop around, not only for different products but also for different agents. This leads to a situation where people are trying more and more to compare these very complex and sophisticated products. This requires more than just a couple of illustrations run at 6% or 7% to see which product gives to lowest premium or gives the highest cash value at age 65 which could be 20 or 30 years from now. It requires us to look at the features and contractual provisions of the product and try to understand the differences not only today, but also what could change in the future and the impact that could have on the results you are seeing on the illustration. Unfortunately as you will see, today's illustrations reflect very little of the reality of how a policy will actually perform in the future.

It is some of these issues that I will try to cover for you in the next few minutes and while I can't promise that you will leave here fully understanding everything there is to know about Universal Life, hopefully you will have an appreciation of some of the complexities and issues that you should be aware of and some of the questions we should be asking in order to compare some of today's products.
On the surface in its simplest form Universal Life doesn't seem that complicated. It works basically like a bank account. You put money in periodically and from the money you have in the account the insurance company takes money to cover its expenses and the risks charges it needs for the insurance coverage it is providing. Any money left in the account gets credited with interest on a tax sheltered basis and as long as the account doesn't run out of money the policy stays in force.

f you look at the early versions of these products that we were selling a decade ago compared to today's products, it was much easier to identify these different factors compare one product to another.

The largest part of a company's expense is related to premium. Commissions have traditionally been a % of the premium. Underwriting expenses are higher on larger policies and policies on older lives and these policies also have higher premiums. Premium taxes of course are a % of premium, and so on. As a result the early Universal Life products had very high front-end premium loads to match these expenses.

The risk charges in the early products were almost always on a Yearly Renewable Term basis which very closely matched the company's actual mortality risk, and as a result the risk charges in the early products could be viewed as being quite close to the net charges needed by the company for underlying insurance.

The investments applicable to the cash value were usually Fixed Term investments for a period of about 5 years very similar to 5 year bank GICs. This allowed the Companies to closely match their investment risk by purchasing good quality Corporate or Government bonds. The credited rates were then established based on these gross yields reduced by a spread to cover the company's investment expenses and risk, and investment related taxes like the IIT.

That was 5 to 10 years ago when things were relatively simple. Over the last several years the environment I outlined for you a few minutes ago has caused all that to change.

The use of these products for investments as well as insurance, and the resulting competition with the banks and other investment products, has resulted in the up front premium loads being reduced to only the 2% required to cover premium taxes, or being eliminated altogether. The bulk of the companies' expenses are still premium related but they now get covered by increasing the internal mortality charges or taking a larger spread off the investments yields leading to lower credited interest rates. This leads to a potential mismatch of expenses vs. the loads in the product and an increased risk for the companies. We have also seen the introduction of surrender charges to offset this mismatch for policies that terminate in the early years, however these surrender charges are rarely sufficient to cover the true expense shortfall.

This means that the internal risk charges are no longer just risk charges but include many of the expense loads as well, more like traditional gross term premiums. It is difficult now to compare products on the basis of their risk charges. Depending on how a company has loaded the expenses into a product and how much they are relying on investment spreads to cover expenses, a product with higher risk charges will not necessarily perform worse than a product with lower risk charges. As well the pattern of risk charges may be different with one product having higher charges in some years and lower charges in others. The whole question of risk charges had been further complicated by the fact that most, if not all, of the products today have the option available to use level, or Term to 100, type risk charges. You might think that this would make things easier to compare since now the charges don't change from year to year. In fact the reverse is true. Level risk charges have just added several more components to the whole equation.

For starters by levelizing the risk charges the company is really over charging in the early years and undercharging in the later years. You might think that this is a good thing because many of the company's expenses occur in the early policy years so this charge can go to cover those expenses. What actually happens though is the company has to set up an extra reserve from these extra charges so that in the later years when the company is undercharging these reserved funds will be available for the company to pay its expected claims. It is only if a policy is lapsed or surrendered that this reserved money is released and available to the company to cover expenses.

That is where the term "lapse supported products" came from. The company has revenue available from the released reserves on lapsed policies to support the expenses and claims costs for the whole block of business. That means that the more lapses a company assumes in pricing a product, the more of this revenue from released reserves it is assuming it will have, and therefore it can charge lower premiums. So what happens if a company doesn't get its assumed lapses? Well that means it doesn't get as much revenue from reserve releases as it expected, and on top of that there are now more policyholders around on which the company will have to pay claims, a double whammy. In other words the company now needs some more revenue.

In today's products about the only place that can come from is by taking a higher investment spread and crediting lower interest on the cash values. Of course none of this gets reflected in an illustration where a level interest rate is assumed forever and the same interest rate is assumed for every product.

As well this whole theory of adjusting future interest rates assumes that there are some cash values in the policies to make the adjustments on. If all the policies are being used more like T100 policies and being funded on a pay as you go basis then the company is in trouble because it could cut the interest rates right to the minimum and still not get any additional revenue from interest spreads. On the other hand if there are significant cash values in these products then a small adjustment in interest rates of only 10 or 20 basis points could make a huge difference in the companies profitability.

As a result the companies have designed these products to encourage prefunding and the build up of cash values. The fact that the interest earned on the cash values is tax exempt helps, and many of the presentations we make emphasize this. This preferred tax treatment also means that for those who can afford it, prepaying the insurance over a few years usually works out to be much more cost effective than the pay as you go term approach. We also see features like discounts on the risk charges for policies funded at a high level and of course every product has some form of bonus interest.

Let's talk about these bonuses for a minute.

The question a lot of people ask is are they real or just a marketing ploy.

My answer to that is a very definite yes and no!

There are some true investment gains possible in these products that can result in bonuses being available.

For example, in pricing the level mortality charges the company makes an interest assumption as to what it will earn on this reserve that we discussed a few minutes ago. If investment earnings are higher than this pricing assumption then the company will have an investment gain on this reserve and can use that gain to pay some bonus interest on the cash values. That is why you see some bonus interest structures that pay higher interest bonuses at higher interest rates.

That only accounts for part of the bonus. There are still substantial bonuses paid on most products at lower interest rates and on policies using YRT risk charges where there isn't the same internal reserve build up.

Part of these bonuses could be funded from the fact that the bulk of a company's expenses occur in the early years of a policy. To the extent that these expenses are covered from some additional interest spreads there could be some spread available to pay these bonuses in the later years.

The more likely source of funding for the bulk of these bonuses is lapses of the T100 policies.

These bonuses then become a bit of a catch 22. They are there to encourage cash value build up so that the company can generate some additional revenue by reducing interest rates if it has to.

On the other hand, the existence of these bonuses can in itself generate a loss to the company that then needs to be funded by reducing the interest rates, and the build up of cash value that these bonuses encourage will fund the policy and keep it from lapsing.

I have heard some companies argue that this can all be self correcting because if they have to cut interest rates on in force policies that will make their performance less attractive and could generate some lapses.

Now that they have some lapses they don't need to cut the interest rates anymore.

It reminds me of the story of the 2 ancient warriors who were sent out to kill the Huns. They were told that for every Hun they killed they would be paid one gold coin. So off they went but at the end of the day they hadn't seen any Huns. Discouraged they lay down under a tree and went to sleep.

In the morning one of the warriors woke up to find that they were surrounded by hundreds of Huns all with their spears pointed directly at them. He leaned over to the other warrior, shook him and said "wake up, wake up, we're going to be rich".

As you can see there are many pieces to the Universal Life puzzle and it is going to require the companies to carefully monitor their experience and react in a timely way to emerging experience trends. If they do a small adjustment in interest rates can make a huge difference provided there are sufficient cash values on which to make the adjustment. We can only hope that over the long run things work out and our clients aren't the ones who suffer.

I will come back to the investment side of these products in a minute, because that is the area where I think there is the most confusion and misunderstanding about today's products. It is however important for us to understand it because it is also the place where companies are going to look in the future to generate the extra revenues they need to support many of these products. First though I'd like to discuss another aspect of today's products that ties in with all of this and can be important to the ultimate pricing.

That is the compensation. Several things have been happening to compensation over the past few years.

First of all the general level of compensation has been reducing as new products are developed.

Obviously this allows the company to offer a lower more competitive price at your expense, and since it is commissions that provide PPI, the company I work for, with its revenue, potentially at my expense too.

There is more to it than that though. The style of compensation has been changing as well.

The highest rates of commissions are usually now paid only on a small portion of the premium, which is closer to the level of the T100 charges than the full premium being paid. Obviously since the expenses are now loaded into the charges instead of directly into the premiums paying on a lower portion of the premium allows the company to better match its expenses with the loads in the product.

Some companies have also introduced compensation that is actually paid on the charges instead of on the premiums. This is an even better match for the company between its expenses and loads, and has the added advantage to you that you still get paid even if a policy skips a premium or is paid up. That means over the long term your compensation may not be reduced as much, just spread out more.

On the other hand, products that still pay premium compensation, but have it loaded into the charges can generate an additional source of profit for companies in the event of a premium skip where they don't have to pay the commission but still get the mortality charge. Premium skips on these products then become another form of lapse support, with the potential to generate some additional revenue and reduce some of the costs.

The final thing that has been happening to compensation is that the ongoing renewals have been greatly reduced or in some cases eliminated altogether.

Sometimes that translates into higher up front compensation, but what happens in the long term? Today's products are increasingly complex and with all of the investment options and other features available, they require an increased level of service in most cases.

I have heard a greater number of comments lately from agents with blocks of this business that are now getting to be about 5 years old, where they are spending a great deal of time servicing the policies but are getting paid very little to do it. I know for a fact that some companies are taking this into account in their pricing.

They are assuming that with reduced or inadequate service, more policies will lapse which contributes to the lapse supported pricing I referred to earlier.

Where long term renewal comp does exist it is often in the form of asset based comp. Therefore you only get paid if the policy is funded at a high enough level to have built up some significant cash values. This relates back to my comments on bonus interest rates. It is one more design feature that encourages the build up of long term cash values. It is once again a potential catch 22 because asset based comp requires an additional spread off the interest rates of about .5% depending on how much the asset-based comp is. Since it usually only kicks in after several years, and even if it is paid from day one it doesn't really amount to much until the policy has had a few years to build up a cash value, it is doubtful whether the companies currently have the full load for this comp built into their current credited rates. This means that like bonus interest rates it is just one more factor that could put downward pressure on credited interest rates over the long term.

So now let's look at the investment side of these products and try to sort through all the various options and features that are available today. A better understanding should help you utilize these options to structure a better program for your clients, and at the same time recognize where some of the risks lie and what options the companies have left open, either intentionally or in some cases unintentionally, to protect themselves.

I found this cartoon in the paper a few weeks ago. It's a couple at a MacDonald's style drive through window and the caption says "We'll have 2 Buy and Hold Combos, one Blind Faith and a side order of rose coloured glasses with Prozac". Unfortunately Universal Life has become a bit like that as well.

The investment options within a Universal Life product used to be relatively simple and straightforward. They were usually of a fixed term or GIC nature and often there was only one term of say 5 years available. In recent years however the rates available on fixed term investments have reduced to the currently record low levels. At the same time the returns available on equity investments have soared to record highs. This combined with the ever increasing competition for the consumer's savings dollar from banks and mutual funds has lead to the development of a wide variety of investment options being available in virtually every Universal Life product on the market today. This wide range of options has created the opportunity for some substantial gains for your clients but also some additional risks, some that are obvious, and some that aren't so obvious.

So let's start by examining the fixed rate options. On the surface these are relatively easy to compare. Companies publish their rates usually on a weekly basis so you know in advance what you are going to get. Most companies rates are within about .25% on each other and if a company is further off the market than that, competitive pressures very quickly bring their rates back in line.

That's for new business but what about in force business. Products are being repriced and new products are being introduced at a very rapid pace these days, so the product you sell today will likely be off the market in few years or even less and any policies you sell will be part of a closed book of business. There is no requirement for a company to credit the same rates of interest on old products as they do on new products. In fact there are already examples where companies are crediting significantly lower rates on old products than they are on new products.

The guarantees provide some protection but most companies have the room to lower their credited rates by a full % or so before they get to the guarantee.

You shouldn't assume that all the linkages within various products are the same. At least one company has a guarantee on its fixed rate investments that looks very attractive, however when you read the marketing material closely you find that the guaranteed rate can be further reduced to cover IIT. The spread required to cover the IIT can be as high as .75%. When you deduct this from the guarantees they are now very close to the competition. It doesn't stop there however. When you read the policy contract you discover that it is not just IIT that can reduce the guarantee but any taxes that are attributable to a policy. While taxes are an issue that every company could be faced with most companies can only pass them on to policyholders to the extent they don't hit the guarantees in the policy. This company has left itself the unlimited ability to pass through taxes to the policyholder without dipping into its other margins i.e. all the future tax risk has been passed on to the policyholder.

If you look at the contractual definitions of the guarantees you will notice that there are many differences from product to product, many of which, like in the above example, can lead to lower guarantees on one product that on the surface appears to have to same or a better guarantee. One final issue about guarantees that has arisen in recent years, as companies have introduced multiple options for investment, is that they have also given themselves the right to withdraw any investment option at any time.

If that is the case then these guarantees are not really guarantees, since if the option is no longer available you can't get the rate of return that had been associated with that option. Some companies have limited this right to discontinue investments to the equity options, and others have guaranteed that they will always support one of the current options like the 5 year fixed rate options. This practice however varies from product to product.

Another question that I think needs to be asked is how do the credited rates on Universal Life fixed rate accounts compare to other investments.

We talk a lot about the minimum guarantees and their linkage to things like government of Canada bonds or T-bills, but what about the actual credited rates. Are people assuming that because of the linkage that they can get yields at the same level as government bonds? The answer is no.

Over the past few years credited rates have tended to be on average about 1.25% to 1.5% below government bond yields.

If you look at 5 year government bond yields over the past 10 years or so they have averaged around 8.5%.

Based on the relationship that exists today between credited rates and government bond yields that would give an average 5 year credited rate of around 7%.

If we compare that to alternate investments like bank GICs over the past few years they have been on average about .75% below government bonds. So you see the banks take a spread as well, all be it a smaller spread than the insurance companies. But there is a reason for this.

Interest earned on bank GICs is fully taxable whereas interest earned in a life insurance policy is exempt from taxation until it is withdrawn.

Instead the insurance companies pay a proxy tax on behalf of the policyholders in the form of the IIT.

As I have already mentioned the spread required to pay the IIT can be up to .75% which happens to equal the additional spread that the insurance companies take over the banks.

Recognizing these relationships is important for 2 reasons; first it can help us in establishing reasonable assumptions about what future credited rates might be based on past experience and assuming that companies don't increase their spreads; and second we often compare the results in a life insurance policy to an outside investment like bank GICs and I think it is important to recognize in that type of analysis that you can earn higher interest in bank GICs than the rates that are usually credited on a comparable option in a Universal Life product.

Otherwise we may be creating overly optimistic expectations and have problems with respect to some of the new disclosure and market conduct requirements. It is interesting to note that even with a lower credited rate, a universal life policy will still out perform a taxable savings alternative like bank GICs.

Another issue with fixed rate investments is market value adjustments. All products have them on their fixed rate investments but once again there are some differences from product to product. Do market value adjustments happen only on withdrawals, surrenders or transfers, or do they also occur on charges being taken out of the accounts? If they occur on charges then if rates are increasing the resulting market value adjustment can result in a surcharge of several % on top of the regular charges.

Things can be even worse in some contracts where the market value adjustment is loaded up and based on rates that are 1% or more above the current rates. In this situation even if rates have not increased the market value adjustment will result in a surcharge of several % on any money taken out of the account. Of course none of this gets reflected in the illustrations but can result in a significant loss of value for your client and a significant hidden gain for the company.

There are many other differences from product to product, like the requirement to leave some money in daily interest accounts, or having all the money go into daily interest accounts unless you request a transfer, etc. All of these can lead to lower yields if you aren't careful, but more importantly it emphasizes the fact that there are many differences from product to product and we shouldn't take anything for granted. You need to know the product you are selling to make sure that you and your clients don't get any surprises later.

Now let's move on to the final area I want to talk about and that is the equity investment options. As I mentioned earlier, these options have been introduced into Universal Life products over the past few years in response to fixed interest rates being at record lows and to increased competition for investment dollars from the mutual fund industry. I strongly believe that these options can provide your clients with some substantial gains and open up some new marketing opportunities due to the unique combination of equities within a tax sheltered insurance vehicle. However, there are also some significant additional risks for your clients and some substantial differences between these equity options and mutual funds. Once again these are things we need to be aware of in evaluating the various products and avoiding some major surprises down the road.

The first thing we need to realize is that despite the fact that we now have equity options these are still not mutual funds but life insurance policies. One of the big differences is that a Universal Life policy is not a closed fund of money but has charges coming out of the fund on a regular basis, usually monthly.

Where these charges come from can make a difference to the performance. Some products take the charges out of the Fixed Rate accounts if there are any, some take them out of the equity accounts first, and still others take them proportionately from all the accounts. I'm sure most of you are familiar with the concept of dollar cost averaging used in mutual funds. The theory is that instead of putting a large amount of money into the fund once a year you should put smaller amounts in more regularly. This immunizes you from dramatic fluctuations and your account becomes less volatile.

The converse is true if you systematically take money out of an equity account. You have the equivalent of negative dollar cost averaging. Depending on the timing of the market fluctuations to when the charges come out you can have significantly reduced performance. The opportunity is there for gains as well but the account becomes more volatile.

This first came to my attention upon looking at the annual report for an actual policy that had paid an annual premium and had it allocated 50% to a 5 year fixed rate account and 50% to an equity account. The theoretic yield for the year on the equity account was 2 to 3 times the interest rate on the fixed account but at the end of the year the equity account had less money. This product took the charges proportionately from both accounts and over the year the equity account had had some decreases even though there was a net gain for the year. With charges coming out after some of the losses the subsequent gains weren't enough to make up the losses because there was now less money in the account to which the gains were applied. Of course the reverse can happen as well, and you can get substantial gains, but the volatility is increased. It all depends on the timing. The approach of having some money in fixed rate accounts to cover charges can reduce this volatility. The decision on how to structure the investm
ents depends on how much additional risk your client is willing to assume for some possible additional gains.

This brings up another point. In modeling products with different investments we should really be modeling the mix of investments, where the charges come from, and in the case of equities a truer pattern of increasing and decreasing returns, not just a level rate that is assumed to be the average long term yield. If this were reflected in the illustrations, I think we would see quite different results. Unfortunately illustrations systems don't allow this but I expect you will see changes in illustrations systems in the future.

Now let's examine these options more closely by first looking at what they are linked to. Basically it can be anything from indices like the TSE 100, the S&P 500, Morgan Stanley world index, etc., through existing mutual funds offered by companies like Templeton or Trimark, or even to home grown investment pools created by the insurance companies themselves. Regardless of which of these types of options you are using, the first question that should be asked is what is it linked to.

In the case of the external indices there are usually 2 to choose from; the price index which reflects only changes in the price of the various equities in the index but not the dividends; or the total return index which does include the dividends. If you look at the historic yields on the indices over the past 10 to 15 years, certainly in the case of the TSE or S&P indices, the total return index has yielded on average about 3.5% more than the price index. That means that on average the dividends account for about 3.5% additional yield above and beyond the price gains. So if the option you are looking at links to the price index the company has about a 3.5% margin right off the top.

Some of the same issues apply to options that are linked to funds. Is the yield being linked to before or after management expense deductions? Does it include dividends? How do flow through taxes on the fund get factored in? These things can make a substantial difference in the yield you are starting with.

Another issue relating to foreign indices like the S&P500 is that currency becomes a factor. Most of the linkages to these indices are to Canadian $ equivalents of the index so that the yields credited to the policy are also subject to currency gains and loses. For example, over the past 5 or 6 years the yields that would have resulted using the Canadian $ equivalent of the index are about 4% higher on average than the comparable US$ yields due to the fact that the Canadian $ has decreased in value over that time period. The reverse could be true over the next few years if the Canadian $ goes back up, i.e. the yields could be lower by 4% or even more. I'm not saying that that is bad because the S&P500 can still give some pretty good gains. It is just that you and your clients should be aware that there is a currency risk and factor that into any decisions you make about using that index vs. one of the other ones.

Now that we have analyzed what the option is linked to the next question is what formula is being used for the linkage.

Most options today that are linked to a price index, guarantee a return of at least 100% of the change in the price index. This gives the company a maximum spread equal to the dividends, which as I have mentioned have averaged about 3.5% a year in the past.

Options that are linked to a total return index tend to give the company a maximum spread in the 3% to 3.5% range making them more or less equivalent to the guarantees on options linked to 100% of the price index, assuming that future dividends continue to yield about 3.5%.

There are however some options where the linkage is to the price index but the company still reserves the right to take another 3% or so off the price index yields. That then gives them a maximum possible spread more in the 6% to 7% range which is a significant difference from some of the other options. Some contracts I have read are very vague as to which index they are linking to. I have questions some companies on this and invariably the answer is the price index. My general rule of thumb is that if the contract is vague assume the linkage is to the price index.

References to things like the Composite index, which are commonly reported on the news, are also generally the price index not the total return index.

Similar practices generally apply to options that are linked to funds instead of indices.

The company usually retains the right to take an additional spread in the 3% range above and spread already taken by the mutual fund Company in determining the yields being linked to. It is therefore very important to know what the linkages are and what spreads are built in before we make any representations to our clients as to what yields they might expect.

One final comment about the linkage formula has to do with formulas that take a % of the index, as the spread.

This type of formula was a carry over from the linkage on fixed rate accounts that is typically expressed as 90% of government bond yields less something like 1% to 1.5%. This type of formula works well in a fixed rate environment but when it is applied to an index some problems arise. Index values do not grow at a constant rate but are subject to extreme fluctuations up and down. These formulas for equities also tend to be applied either monthly or daily, not annually. They are also structured so that the company takes a spread of say 10% of any gains but also increased any losses by 10% as well to protect themselves on the downside. In that case the company's margin is not 10% of the annual change in the index but 10% of the total of all the changes that have occurred either daily or monthly during the year.

Let's look at an example.

In 1996 the TSE 35 total return index increased by 30%. A 10% margin applied to the annual change would give the company a 3% spread.

The total of the monthly changes up and down for the TSE 35 total return index in 1996 however were 52%. So a 10% margin applied monthly now gives the company a 5.2% spread, that's almost double.

The daily figures give a total of all the changes of 125% for a total spread to the company over the year of 12.5%, about 4 times the annual figure. Fortunately this type of linkage formula has largely disappeared but it was quite common in up until a about a year ago and there are still some products that use this approach.

Now that we have examined the linkages, which define the guarantees within the products, what is actually being credited?

Once again, unlike the fixed rate investments where comparisons are quite simple, on the equity side there has been very little information available and even when we get the information it is often difficult to do a valid comparison. Let's look at some examples.

First, unlike fixed rate investments where the rate that will be credited is known in advance, with equities the interest is not known until after the fact and is very dependent on the date on which the calculation is being done since the equity indices change daily.

Looking at the TSE 35 total return index again, I told you a minute ago that it increased 30% in 1996. That was measured on Dec 31. If you look at the same figures as of Jan 2, 1997, one day later since the stock market is closed on Jan 1, you get 27.8%, over 2% lower in one day.

Putting that into the context of a Universal Life policy we tend to measure annual performance based on policy years not calendar years, so I looked at what one company's credited rates for that index were over 1996 for each 12 month period ending on every day in January 1997. Those rates varied from a high of 28% to a low of 22%. That's a 6% difference depending on which day in January you had your anniversary. Now over the long term these figures will all average out but this demonstrates the short term fluctuations you can experience.

Getting back to the question of analyzing credited rates, based on the above example you could have 2 companies with the same option. One saying that there credited rate was 28% and the other saying 22%. How are we to know if one company is really 6% worse than the other is, or if some or all of that difference is due to timing as it was in my example? The only really valid way to compare credited rates from one product to another is to look at the formula being used not the actual rates.

So let's do that once again looking at 1996. One company credited the TR index minus 2.5%, another credited 100% of the price index, and a third credited the price index minus 2.2%. If we go back to the statistics I gave you earlier, the difference between the TR and Price indices is the dividends which average about 3.5%. So looking at these crediting formulas company 1 is about 1% better that company 2 and over 3% better that company 3. Company 3 ends up taking almost a 6% spread off the total return index. That is quite a difference. By the way these are actual results from 3 major companies all who are very active in the UL market.

As information is starting to come out on credited rates on these options this sort of variance is quite common. Unlike the fixed rate side where companies have historically credited up to 1% or so above their guarantees, many companies are crediting the guarantees on equities, but not all companies are. It appears that the products with the lowest or most aggressively priced mortality rates are crediting the lower rates. If you run your illustrations and reflect some of these differences in crediting rates you find that you get a whole different picture. I'll repeat a comment that I made earlier when we were talking about mortality charges. The products with the lowest mortality charges will not necessarily out perform those with higher charges. It all depends on other factors like what interest gets credited to the policy.

I realize that many of the issues I have raised today are difficult to quantify, which doesn't make our jobs any easier. Incidentally many of these same issues apply to Whole Life Par and the relationship between current dividends and what our expectation of future dividends should be, as is evidenced by the current problems the industry is having with vanishing premiums.

I have tried to cover a lot of material in a short period of time this morning, some of it quite technical, and I may have left you with more questions than I have answered. However, in the context of the new disclosure and market conduct requirements, these are questions we should be asking and the companies should be answering.

I strongly believe that today's products are very good and powerful financial tools that can provide some unique solutions to our clients financial needs. However the days of just looking at illustrations run at a common interest rate are gone. We need to look deeper into these products to try and gain a better understanding of how they work. The fact that you organized this seminar this morning tells me that you feel the same way and are already well on your way to doing this.

I'll leave you with I general rule I follow. If the illustration looks too good to be true it probably is, and that should be your first signal to ask some questions. All companies are working with the same basics. They receive premiums, from which they have to cover their expenses, including your compensation, and provide benefits to their policyholders, your clients. In the end hopefully they can make a profit. If one company is taking in much lower premiums then something has to give. They will still do everything they can to make a profit, otherwise they go out of business. That means either you will get paid less or your clients will receive reduced benefits, or no benefits at all if they ultimately lapse their policy.

I've found by doing a little digging, an explanation can usually be found.

By: Ron Atkinson
Vice-President & Marketing Actuary
PPI Financial Group

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