While pundits have the nation hurtling toward a fiscal cliff in 2013, the insurance industry is approaching its own precipice in the form of Actuarial Guideline 38 (AG38) and a Valuation Interest Rate Adjustment that goes into effect on January 1.
The primary goal of AG38 is to require higher reserving for UL products with secondary guarantees; the lower cost UL contracts with little or no cash value but with a death benefit guaranteed to last for the lifetime of the insured. This will raise the rates on almost all of these contracts. The Valuation Interest Rate Adjustment will require higher reserves for annuities and life insurance products with terms of 20 years or longer. Below is a summary of the changes these provisions may cause over the next couple of years.
For policies that have not already been adjusted, look for higher rates, particularly on policies of longer duration and those with a refund of premium feature.
With the regulatory changes you can expect:
- Lower guarantees
- More expensive riders
- Continuing low cap rates
- Smaller bonuses
- Lower commissions
- Lower initial deposits
Any sales edge offered by bonuses, guaranteed roll-up values and guaranteed withdrawal values is liable to become more expensive or less generous.
Universal life guideline level premiums are calculated using a 4% interest rate. If non-forfeiture rates are lowered, the minimum monthly premium necessary for funding a UL policy may exceed the maximum allowed to maintain its status as life insurance under the Guideline Premium Test. There will either be changes in the allowable interest rate or more UL products will become available using the Cash Value Accumulation test.
Secondary Guarantee UL:
UL products have always had lower reserve requirements than whole life products. UL carriers see AG38 as the whole life carrier's attempt to level the playing field between the two guaranteed products. Whole life carriers see this as regulators finally telling UL carriers to get real. In most secondary guarantee products the lifetime guarantee is calculated using different assumptions than the base product. This is why the base product illustration shows the product running out of cash while continuing to offer the death benefit. Thus the "secondary guarantees" have to be calculated using more aggressive assumptions than those guaranteed in the base contract and often more aggressive than the assumed rates in the contract. You can expect that the premiums for secondary guarantees will increase, commissions (already being paid on very low premiums) will fall even further, and a number of products will probably simply be withdrawn.
Whole life products will be facing their own challenges brought about by the change in valuation. For the first time valuation rates will drop below 4%. This will require whole life carriers to carry higher reserves at a time when investment returns are at an all time low. The result of this interest rate drop will generally be higher guaranteed values and higher premiums.
It may seem counterintuitive that a drop in interest rates would result in an increase in cash value, but it does point out one of the key design differences between UL and WL. A drop in guaranteed interest on a UL plan would cause lower cash values because the values are dependent upon the accumulation of premiums paid, less mortality and expense loads, at interest. WL requires that the contract endow at maturity, thus a lower interest rate requires a higher guaranteed cash value.
Many companies have already made changes and many others are in the process. No one likes to see rates increase, but ultimately this is a consumer protection. Adjustments should be made in this interest rate environment to assure policyholders that companies will be around to honor their future obligations.
Contact Marketing Financial for more information.