Life's Dissolution. (Life/Health).
Variable life insurance didn't exist in the United States back in 1973 and 1974, the last time the nation experienced a bear market this long and deep. So there is no historical perspective on how the product will emerge from this bear market, how the life industry manages fallout from these difficult times and whether it will make any adjustments to its marketing strategies or product structures.
Policyowners have known, or should have known, that variable life is not the type of guaranteed insurance that their fathers owned. Owners of these products, particularly the wildly popular variable universal life, know they trade death-benefit guarantees for the chance of building high cash values. In good times, when selected underlying investment options perform well, cash values can be so high that policyowners can skip premiums (with variable universal life) or borrow tax-free and at negligible rates later in life. With variable policies, life is a breeze when the bull runs.
But if selected options perform poorly, as many have since March 2000, policyholders can be in a bind. Not only can their cash values fall, but the planned premiums may not be enough to keep the policy afloat. Without putting extra money into a policy, it can lapse, leaving the insured without insurance and what turned out to be a very costly term policy no longer in effect. With variable policies, life is a storm when the bear comes.
Time to Reassess
By design, most variable universal life policies are funded well enough to withstand a bear market as tough as this one has been. But Dick Weber, author of the life insurance illustration regulation now in use, estimated that 25% to 40% of variable universal life business each year is of the "thinly funded, competitive-premium variety" and is unlikely to meet customers' long-term objectives. A subset of those policies may self-destruct in the short term, he said. "Companies have an obligation to review their blocks of variable life and ascertain, as best as possible...which policies are heading for disaster," Weber said in October, after markets had bounced back from their lows of Sept. 21 -- the end of the first week of trading after the terrorist attacks. Then they need to systematically communicate with agents, and agents with clients, that customers will need to reconsider funding of their policies, he said.
Weber maintains, however, that anyone who owns a variable universal life policy would benefit from a reassessment. He is a life member of the Million Dollar Round Table, an independent assessor for the Insurance Marketplace Standards Association, and has 32 years of experience in the life insurance industry. His recent work as vice president and director of strategic marketing with Financial Profiles, a Carlsbad, Calif.-based financial software developer, has taught him that beyond the 25% to 40% of variable universal life policies and the subset with acute problems, those bought with certain performance assumptions also might need attention.
What kinds of assumptions should raise a red flag? For one, a 12% return compounded annually--particularly on policies bought in the past five years, or even the past 10. (For the five-year period ended Sept. 30, the average stock fund returned 4.98% a year vs. 5.42% for the average taxable bond fund, according to Lipper Inc.) "I suspect not very many policies have done fabulously through this period," Weber said. "You had to have been in the right funds at the right times, and switched to fixed-income funds in 1999. Not many people, in fact, got the full advantage of the bull market."
More insidious, and really at the heart of Weber's work at Financial Profiles, is that annual compounding just doesn't happen in equity markets, even though the illustration regulation he authored--permitting insurers to illustrate policy performance at up to a 12% gain every year--has no basis in reality. For comparison's sake, the regulation also requires that policy performance be illustrated at returns of 0% a year, but not at less than 0%.
Weber now advocates illustrating on a probability basis--the probability that a policyholder will reach long-term goals assuming an average annual return, but taking into account the inherent volatility of the markets. "Calculating values at a fixed rate of return has got to be nuts," he said. "Unfortunately, the market of the past 18 months has borne out our concern. There had to be a way of demonstrating that."
Finding a way has been a Financial Profiles project since the late 1990s, when bulls were still running hard. The resulting software program uses sales-volume data from A.M. Best Co. to determine which specific products represent an aggregate of 80% of the market share in five products: variable universal life single and survivorship, universal life single and survivorship, and 10-year level-premium term. The research allows the company to create an actuarially certified database that allows the software to produce an illustration reflecting the current marketplace for each product. It also incorporates historical large-cap stock returns going back 55 years as provided by Ibbotson Associates, a Chicago-based consulting firm.
During those 55 years, about two-thirds of monthly returns were positive and led to an average compounded rate of return of about 12%. Assuming a 12% rate of return every year, Weber calculated that a 45-year-old male nonsmoker would pay an annual premium of $6,970 to have his $1 million variable universal life policy endow-- reach face value--at age 100. Using the new software, however, he found that the policy would lapse at age 88 due to a low cash value if he applied the historical monthly returns in the order in which they actually occurred.
To further illustrate the effects of volatility, Weber projected the same policy miraculously achieving a 12% annual return for 40 years, to age 85. The cash value at that age would be $360,000, precisely on track to reach $1 million at age 100. But then Weber assumes a 10% market decline in the following year, leaving the policyholder far behind at $324,000. To make matters worse, the cost of insurance at age 85 is $74 per $1,000 of coverage, and the lower cash value results in a greater net amount at risk. The result is a "double whammy" that makes survival of the policy to age 100 highly unlikely without the policyholder infusing it with huge amounts of new money.
Volatility can cause many thousands of such possibilities, of course, and Weber's software, using the Monte Carlo simulation--part of the program that calculates risk probabilities--is designed to illustrate both the range and probability of achieving the intended goal. Clients comfortable with a 70% to 80% chance of achieving their long-term goals might well be suited for a variable universal life policy, Weber said. But if they want a 100% assurance, they would be better suited for a guaranteed product, such as whole life.
Because of the software process, Weber has observed that assuming 12% annual returns is too optimistic. He suggests assuming 8% to 8.5%. For the 45-year-old male in Weber's example with the $1 million variable universal life policy, the probability of the policy endowing at age 100 is 75% to 85% at an average annual return of 8.6%. The software shows that an assumed 8% return "will inherently offset most of the future volatility," he said.
Product suitability always has been a tough issue for insurers and producers, and this bear market may have tested the mettle of policyholders in unanticipated ways. One industry consultant who believes that is the case is Rita Numerof, president of Numerof & Associates, a strategic management consultant firm in St. Louis. The most serious market decline the variable universal life product has experienced has led her to believe that many variable universal life policy buyers did not have as much risk tolerance as they or their advisers thought they had.
These are people who do not ordinarily buy individual stocks and bonds but have gone into the markets through variable universal life policies, said Numerof, who works with companies in many sectors, including financial services and insurance, multinationals and global businesses. Clients include Hartford Financial Services, Merrill Lynch, Bank of Montreal and Harris Bank. These policyholders typically do not have extraordinary net worth or high incomes. Many are educators. While the policies they bought may well be in their best long-term interests, they need extra attention from insurers and producers if insurers hope to conserve those assets.
"You have this middle group buying into VULs, in part because of the investment property associated with the product, but their risk profile from an investment perspective is relatively low," she said. They are clearly interested in life insurance, but they are not interested in having a risk, she added.
Numerof said clients have told her they have experienced a reduction over the last year in their variable life business as policyholders have pulled out of the contracts and as clients have "seen a dramatic drop in their ability to sell new policies." The Sept. 11 terror attacks made all of that worse, along with the ensuing anthrax scare, said Numerof. "All of the confidence people were trying to regain has slipped," she said. "The markets have come back since, but things are still very unstable in the Middle East. All this uncertainty will reinforce people's fear and risk aversion, and layoffs will mean people won't have discretionary money to invest."
Companies need to take special steps to manage policyholders' anxiety so they continue to invest and not look just at what's happening today, Numerof said. "They need reassurance through whatever personal relationships companies have with their contract holders," she said. Companies need to send statements that talk about concern for the well-being of Americans and the economy and what they are doing to support those causes, state a sense of national pride and provide advice. She suggested doing these "in a tiered way," so people with more money in accounts receive more attention.
"Stability is very important," she said. "For most people, this is very scary, and we need to be sensitive to that. But we need to assure them there is a future and will be a future. It's the only choice we have."
Insurers selling variable universal life policies to wealthier individuals have fared better during the bear market. New York Life Insurance Co., which has about 125,000 variable universal life policies in force, reported no uptick in lapse rates and no increase in calls from clients to agents. "People understand there will be ups and downs," said Mel Feinberg, senior vice president, individual life. "That's a testimony to the fact the policies were sold right to begin with. At the home office, we haven't gotten any calls from clients."
New York Life's resistance to lapses is at least partly attributable to no-lapse guarantees in its more recent series of policies. At no extra charge, the company provides a no-lapse guarantee for three years if certain minimum premiums are paid. For an extra charge, the no-lapse guarantee can be extended to as long as age 100, again if premium requirements are met.
But the company has seen a switch in interest among recent buyers, away from variable universal life and toward more conservative types of policies. Year to date through mid-October, whole life premiums were up 25%, universal life was up about 50%, and term life was up 20%, according to Feinberg. "We're not necessarily trying to move people from one to the other," he said. "This actually might be a good time to go into VUL products, in that people might buy low. Some agents have actually increased their VUL sales."
Feinberg said New York Life has been thinking about creating a program that would identify specific policies at risk of lapsing, and the company still might create one. The company currently uses statement stuffers to encourage policyholders to add money and take advantage of the tax-sheltered cash-value growth opportunity. To encourage unscheduled payments, it will next year add a tear-off to the statement with the address of the service center, Feinberg said.
The quarterly summary for Feinberg's own variable universal life account showed him that unit values are way down, but he still has a positive surrender value, so all his charges are covered. A special section in the summary showed him what his policy values would be a year later, assuming a 0% net investment return and no contributions. "My policy would barely make it, but I fund my policy monthly," he said.
Tapping the Affluent Market
Lincoln National Corp. has actually seen a slight improvement in its variable universal life policy lapse rate--which averages about 3% to 4% a year--during the bear market, and its total variable life sales have grown by 10% for the year through late October. According to A.M. Best Co.'s sales studies, Lincoln National's in-force amounts grew the fastest among the top-10 insurers in 1999, rising by more than 146% from the previous year to more than $18 billion. "My guess is that it's the type of market we're serving," said Steven Roche, second vice president and business leader for variable universal life products, in Hartford, Conn. "Everyone says they're in the affluent marketplace, but if you look at average policy size, we're either No. 1 or 2 in the industry. Our policyholders are more sophisticated, and we have more sophisticated advisers. They know there are times markets will decline."
Bob Klein, vice president and national life sales manager for Lincoln Financial Distributors, the corporation's wholesaling distribution arm, said he hasn't seen higher lapse rates, either. He manages the wire regional channel for Lincoln from Fairfax, Va. He said most questions from the field to Lincoln's wholesaling force since the end of last year are about how to design cases and what products to use. "At the end of last year, the default illustration on variable life was a 10% gross rate of return, and distributors wanted to know if they could illustrate 20%," he said. "We had that lovely discussion telling them they can't show more than 12%. Now that has crept down to 9%, and even to 8.5% or 8%, so it has had a significant impact on funding decisions."
Klein said Lincoln Financial Distributors has two basic markets: the affluent estate-planning market and wealth accumulators. The latter overfund their policies by design in hopes of generating supplemental retirement income. "So there's no impact there," Klein said. "They understand this is a long-term deal and why they're overfunding."
But there has been some movement among older high-net-worth clients, those 60 or 65 years old, who previously said they wanted some insurance money in the stock market. "More of them are now asking about fixed products again, because they have less of a time horizon," said Klein. "In our world, they're mostly interested in a fixed universal life policy with no-lapse guarantees."
Gary Ranftle, a financial planner who is a member of Lincoln Financial Advisors, Lincoln's fee-based financial-planning arm, said Lincoln's variable universal life products are well funded and provide time for markets to recover. But some clients are inquiring about the status of their policies, said Ranftle, who works out of Sage-mark Consulting, Syosset, N.Y. "Clearly, the projections have changed," he said. "We suggest they wait it out or put more money in. A certain percentage, very low, has switched to UL contracts, and about the same percent has switched to bond portfolios within their VULs." Those switching to universal life contracts intend to remain invested in bonds; variable universal life contracts annually charge an extra layer of expenses of about 1.5% of assets, Ranftle said.
Lincoln Financial Advisors' clients in the New York area have a net worth of at least $3 million, said Ranftle. The planners provide in-depth analysis of different types of insurance and illustrate variable universal life policy performance assuming a wide range of scenarios, including a return of minus 20%. A large portion of clients pick universal life, because most are ages 55 to 85, have accumulated enough assets and want to preserve them, he said.
The older clients are, the more they want no-lapse guarantees, said Ranftle. "Anything over age 90, and they're happy," he said. "There might be 25% more in policy cost to guarantee to age 100. We devote a whole meeting to explaining how we can structure an insurance policy, what they're giving up and where."
Revising Policy Illustrations
Feinberg said New York Life has rethought its marketing strategy for its variable universal life policies, including an emphasis on death-benefit guarantees. It already automatically illustrates policy performance at 8% a year whenever an agent runs an illustration at 10% or 12%. Some agents have asked about factoring volatility into illustrations, and Feinberg said the company might consider it next year. He said Weber has visited company headquarters in New York to show his software program, but company leadership decided to wait to see whether the National Association of Securities Dealers would endorse the software.
Weber said the NASD considers illustrations to be advertising materials in a broad sense, and broker-dealers across the country have been insisting that vendors, such as Financial Profiles, obtain an NASD endorsement. The NASD is not happy about being put in that position, but Prudential Insurance Company of America met with the organization to encourage it to respond, said Weber. Prudential, which was in the quiet period preceding its initial public offering, declined to comment. Weber said Trasamerica Occidental Life Insurance Co., Los Angeles, and Guardian Life Insurance Company of America, New York, have been interested in the software program, but appropriate sources at those companies could not be reached for comment.
The bear market has had minimal effect on employer-sponsored variable universal life plans. W. Thomas Lobaugh, a Chicago-based broker with Willis Inc., said these policies are either underfunded or overfunded. In the former, the employer pays term charges only, and employees may choose to build cash values with their own payments to structure a tax-free payout in retirement. Most employers pay the insurance costs until the employee retires or leaves.
In overfunded plans, employers pay the term charges and fund separate accounts. Companies use these programs as executive benefits or as replacements for group term life. Since Lobaugh advises employers to assume only a conservative investment return, the plans are overfunded even in the down market. Lobaugh predominantly uses variable universal life policies from Pacific Life Insurance Co., Newport Beach, Calif.
Lobaugh said he has a client, a major company in the auto manufacturing business, with 12,000 variable universal life policies to fund a deferred-compensation plan. Though the company had always chosen conservative investment options, it recently made a decision to become more aggressive. "It concluded a lot of stocks were selling at a bargain price," he said.
For those policies that have hit dangerously low cash values, however, or may in the future, there is a compelling message that the industry must heed, Weber said. "It's a message to an industry that is like a deer in the headlights," he said. The industry "clearly understands a wave of class-action lawsuits are brewing, and those lawsuits will make the 1990s' lawsuits look like a picnic. The illustrations don't reflect volatility, and we're not telling even our agents."
Weber said the industry fears that illustrations showing lower returns--and thus requiring higher funding--will result in lower sales. "But that is not my experience as a practitioner," he said. "We don't give people credit for their ability to understand. People just want to hear the truth so they can make intelligent decisions."
Lower Premiums vs. Chance of Success The following policy illustrations for a $1 million variable universal life policy calculate the annual premium based on age and projected rate of return when applying random historic performance of a 60/40 Large Cap/T-Bill portfolio. Insureds are male nonsmokers. Success is defined as having the policy still in force at age 100. Projected Rate Chance of Age of Return Premium Success 45 12% $6,970 10% 10% $8,500 45% 8% $10,780 90% 55 12% $13,990 10% 10% $16,150 45% 8% $19,070 (*) 85% 65 12% $28,050 15% 10% $29,420 50% 8% $34,300 85% Notes: Chance of Success calculations are approximate and based on random variations of past historical data. While any given probability shown in this chart is reliable as to that historical data, it is still not a "prediction" of actual future performance. (*)Average death benefit/cash value at policy maturity equals $4,750,000. Source: Financial Profiles Inc.
RELATED ARTICLE: Low-Load Liquidity Works for Some
One group of fee-only planners has avoided the danger of variable universal life policy lapsation by using only low-load variable universal life with their clients, said Joseph W. Maczuga, executive director of the Fee Planners Network, Troy, Mich. These products, the most dominant of which is offered by Ameritas Life Insurance Corp., Lincoln, Neb., do not pay commissions and can offer first-year cash values as much or even more than the first-year premium. Market declines, therefore, do not affect low-load policies nearly as much as traditional-load products, Maczuga said.
Low-load liquidity is further enhanced by the fact there is no surrender charge. A load product calculates cash value and surrender value, Maczuga said. The extra liquidity of low loads provides a safety net in difficult times.
For example, Maczuga calculated that if the $26,000 target premium of a commissioned $1 million policy on a 55-year-old male nonsmoker is paid only one time, the cash value after one year is $7,800, and the policy lapses in the second year. For the same low-load policy, a $26,000 premium would provide a cash value of $24,700 after one year, and the policy would last 7 1/2 years with that single payment.
Low-load variable universal life policies make up a tiny part of the market, however, mostly because they are sold by practitioners who are paid for their services rather than through product commissions, such as fee-only planners.
Maczuga said his older clients were already in asset-preservation mode before the bear market hit. He advised younger clients either to wait for the markets to come back or, if they had a higher risk tolerance, to select aggressive, contrarian-investment options in the policy, such as offerings from the Rydex group of mutual funds designed to earn money when the market goes down. Maczuga also has some younger clients who have shifted out of stock funds into a money-market account and are now dollar-cost averaging back into stocks.
In some cases, Maczuga said he has taken advantage of the high liquidity to actually remove some capital from a low-load variable universal life policy so it can be invested in nonequity investments, including real-estate trusts or equipment-leasing programs.
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|Article Type:||Brief Article|
|Date:||Dec 1, 2001|
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