In a recent Blog (Blame Bernanke? My Guess Is They Will Blame The Trustee), I wrote about the negative effect that falling interest rates have had on Current Assumption Universal Life (CAUL) policy performance. In it, I cited an article that focused on “today’s (artificially induced) low interest rates” and I made the case that today’s historically low rates “are not helping, but…these policies have not lived up to expectations for decades.”
While this is true, today’s interest rate environment is unprecedented and the strain that it is putting on carriers is beginning to show.
In a Universal Life policy, the carrier can make money at least two ways. First, on the cost of insurance (COI) and other expenses it charges. Second, on the spread between what the carrier makes on investments and what it pays out to the policy (the crediting rate on cash value.) In older policies the guaranteed crediting rate is typically 4% (newer policies have a lower guaranteed rate of 2% or so, reflecting today’s new environment.) Carriers are having trouble generating returns to pay even the guaranteed crediting rates on older policies. So, if a carrier cannot make money on the “investment spread”, where can they make the money? You guessed it…on the cost of insurance.
A representative of one Universal Life carrier recently told us their “actuarial (department) is currently doing an expense, mortality and interest study” and “by the end of 2013, COI is anticipated to increase up to the guaranteed maximums.”
This is a major development. In the past two decades while the interest rates were dropping, those of us managing life insurance policies could count on the fact that cost of insurance charges were stable. Some carriers even lowered the charges below what was shown on the original sales illustration.
What could the effect be on policies in your portfolio? In this particular case the policy is on a male, preferred plus non-smoker, currently age 54. The cost of insurance in this policy has increased each year for the last 7 years at a 5 – 8% annual rate…a little high maybe, but not out of line. If the policy were to go to guaranteed rates in the next policy year, the percentage increase in the cost of insurance would be in the 450% range!
While we do not know the outcome of this situation right now, it is certainly a scary harbinger of things to come. ITM will continue to monitor the situation and provide updates as warranted.