State crackdown could be the death of some universal life policies

State regulators have signaled a push for recalculating reserve requirements on a certain type of universal life insurance — which could lead to higher costs for policyholders as well as fewer carriers’ selling the product.
A group of state insurance regulators last week approved a statement indicating that some life insurers are holding insufficient reserves — liabilities carriers must hold to ensure they can pay future claims — for their sale of universal life insurance with secondary guarantees.
Regulators’ focus is on a certain type of UL policy that allows customers to pay a minimum amount of premium to keep in force a secondary guarantee — which ensures the policy won’t lapse. They claim some companies are reserving based on the assumption that customers are paying higher premiums, which leads to lower reserves. Carriers would have to hold more reserves if they based their calculations on the assumption that a customer is paying the minimum to keep the secondary guarantee intact.
Some insurers, including Lincoln National Corp. and Genworth Financial Inc., have railed against the claims, writing in to the National Association of Insurance Commissioners’ Life Actuarial Task Force, the group that approved the statement on reserving last week.
“There is no evidence to support the position that companies are holding inadequate reserves,” Lincoln chief executive Dennis Glass wrote in a letter to the task force’s chairman, Leslie Jones, who is chief actuary of the South Carolina insurance department.
“Even if there were [evidence that carriers were holding an inappropriate level of reserves], however, it would have been inappropriate for [the task force] to make public comments on those matters,” Mr. Glass wrote.

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The discussion is a long way from a requirement that insurers step up their reserves. Now that task force has approved the statement on reserving, the NAIC’s Life Insurance and Annuities Committee will take up the measure, followed by the Executive Committee and NAIC Plenary.
Still, observers note, higher reserve requirements would likely lead to higher prices, fewer carriers offering the product and stunted profitability for insurers and their shareholders.
“If companies discovered how to reduce reserves and regulators clamp down, you have to ask whether the companies were making more money on the product or did they lower their prices for customers in line with the cost savings,” said Joel Levine, senior vice president at Moody’s Investors Service.
Universal life with secondary guarantees made up about 43% of new UL sales year to date through the second quarter, according to LIMRA. Five years ago, the product accounted for 47% of new UL sales.
Since the 2008 financial crisis, customers have attached even greater value to such insurance. Sales of UL with secondary guarantees at Commonwealth Financial Network were up more than 40% year over year in 2010 and continue to “chug along,” according to Brian Harrison, director of insurance marketing at the independent broker-dealer.
“I would think it’s the easiest product to sell,” said Jim Swink, vice president of Raymond James Insurance Group. “You’re getting a guaranteed death benefit for your guaranteed premium outlay.”
Distributors are keeping a wary eye on the regulatory development for now, relying on ratings agencies and insurers’ risk-based capital metrics to reflect insurers’ strength.
Companies are holding UL reserves at or above economic levels, said Andrew Edelsberg, a vice president at ratings agency A.M. Best Co. Inc. The tiff between regulators and insurers, however, will affect companies’ ability to sell competitively priced products, he said.
“It’s one of those things where you’re an interested observer, but it’s not anything we can be involved with on a daily basis,” Mr. Swink said of the regulatory discussion. “We’re never above the fray, because the bottom line is, you’re recommending this product to one of your clients.”
Advisers and clients alike prefer the fact that coverage is guaranteed for the remainder of the customer’s life even if the cash value falls to zero, provided the client makes minimum premium payments. Further, in situations where carriers have been using lower reserves, insurers are passing the savings on to customers in the form of lower premiums.
Carriers are in a bind because there are few ways for them to wring out more costs from the product design.
The structure of the products makes it hard for carriers to raise premiums on in-force policies. Further, insurers’ secondary guarantee UL businesses are lapse-supported, which means they are counting on a certain number of policyholders to lapse their coverage.
UL policies with secondary guarantees have been sold for close to 10 years, insurance executives say. The American Council of Life Insurers asserts that the LATF group’s statement appears to apply to in-force business.
“Such application would be unreasonable, given that companies collaborated with their domestic state insurance regulators before these policies were written to ensure they were in compliance,” said ACLI spokesman Whit Cornman.
Observers also noted that increased reserves could lead to a shakeout of the marketplace for UL with secondary guarantees.
In recent years, a handful of insurers have either exited that business or repriced the policies to the point that they’re not competitive, largely due to fewer lapses than expected and lower interest rates. Low interest rates hamper insurers’ ability to earn investment income, and products that guarantee a certain interest rate — which is the case with UL — are particularly affected by low rate environments. Insurers that have abandoned the product include Sun Life Financial Inc. and Axa Equitable Life Insurance Co.
Greater scrutiny on reserving merely adds another challenge for market participants and could lead to more exits, said Larry J. Rybka, president and CEO of ValMark Securities Inc., an independent broker-dealer specializing in life insurance.
Naturally, profits would also ebb following higher reserves, another casualty of the triple whammy that could be facing issuers of UL with secondary guarantees.
“Companies can take a lower rate of return on their own investments or they can pass the loss of profitability to the customer by raising the insurance cost or they can do a combination of the two,” Mr. Swink added. “One of the insurers’ primary goals is to optimize profitability for shareholders.”