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The real value of nonforfeiture benefits: nonforfeiture regulations must change with the times to protect consumers.

IN TODAY'S REGULATORY environment, owners of universal life insurance are not getting the same level of protection against forfeiture as those who own whole life insurance with similar guarantees. The current nonforfeiture law with its origins in the late 1930s is designed to protect a policy owner's equity in a permanent life insurance contract. Yet, consumers who own UL policies with secondary guarantees receive less protection under the current interpretations of this law as these policies are held to a lower standard.

Nonforfeiture benefits safeguard policyholders by providing a fair value in the event a premium does not get paid. Cash surrender value, reduced to paid-up and extended term are all examples of nonforfeiture benefits.

It is not uncommon to hear actuaries state that if nonforfeiture benefits were not required, life insurance would cost less. While this may be true, it should not be the overriding reason to negate nonforfeiture laws. Consumer protection does not necessarily mean providing products at the lowest possible price.

A FINANCIAL SAFETY BELT

Think about it this way. Early model cars didn't have safety belts, air bags or crash absorbing bumpers--all of which add to the cost of the vehicle and are totally unnecessary for a car to function. If they were optional, there's no doubt many buyers would choose to save money by not purchasing these features. However, safety has been deemed more important than cheaper cars and the government requires all new cars to be equipped with minimum safety features to protect the driver and passengers.

Nonforfeiture benefits act as a seat belt on a life insurance policy, as they safeguard the policy owner's financial interest in the policy.

IMPACT ON THE INDUSTRY

Because current nonforfeiture law does not apply to the no-lapse guarantee features of universal life insurance, many insurers are offering these guarantees without significant nonforfeiture benefits. Here's the catch: without material nonforteiture requirements, companies rely heavily on lapse-supported pricing. Pricing based on an inflated lapse assumption can unravel insurers' financial strength if people do not surrender their policies as anticipated.

There are a number of reasons lapses may not occur at the rate companies had assumed in pricing. First, without nonforfeiture requirements, companies are free to assume a higher level of lapses simply to drive down premiums. Secondly, if people receive nothing for surrendering their policy, they may prefer to keep it. Rather than surrendering their policy and getting nothing in return, policy owners who feel they no longer need the coverage may prefer to sell their contracts in the secondary market. A policy owner can estimate a fair market value by using a combination of life insurance and annuity quote services (see sidebar).

Historically, companies that assumed relatively high lapse rates (in pricing other lapse supported products) and later found actual lapse rates to be rather low were forced to raise reserves considerably. Thus, significantly weakening their surplus position.

PRINCIPLES BASED ON CONSUMER PROTECTION

While companies can address the financial ramifications by raising reserves, the fairness issue must be addressed through industry regulation. Although the current nonforfeiture law may be obsolete, the principles on which it was based are as pertinent today as they were more than a half-century ago. The guiding principles of current law (from the 1941 Guertin report) could provide the framework for a nonforfeiture law for any product in any era. In summary, they seek to:

* Protect policy owners from losing the value created in their contract.

* Give companies the right to adjust a policy's value so persisting policy owners are not inappropriately harmed.

* Ensure that the standards do not harm insurers' solvency.

The reality is that consumers sometimes forget or do not pay their premiums. In the absence of nonforfeiture benefits, there would be cases where the policy owner does not understand the value of what he or she is giving up. In the end, nonforfeiture requirements benefit the well-being of clients and the reputation of insurance companies.

REVISE, DON'T ABANDON, THE STANDARD NONFORFEITURE LAW

Attempts to develop some consistency between the nonforfeiture benefits offered by universal life and traditional life insurance products have failed to gain the industry's support for a variety of reasons. Yet, the existing law needs to be changed to treat all product types consistently. Without a new law, there is uneven and inadequate protection of consumers. Nonforfeiture benefits provide assurance to the buyer that the company has accounted for the benefits funded by past premiums. They not only serve the buyer but also the regulators.

Before a more uniformly applicable law can be enacted, the principles upon which to base the law need to be determined--those outlined above would be a great start. Nonforfeiture benefits are in the best interest of consumers, just like other safety measures in our society.

RELATED ARTICLE: Hidden treasure?

SAY YOU ARE A 65-YEAR-old man in great health. You've been paying $6,000 for a $1 million policy for the past 25 years. The policy is guaranteed not to lapse for your lifetime, as long as you pay the $6,000 premium, but you don't need the insurance right now and the company provided cash value is $0. You have a feeling this policy is worth something--but how much?

CONSIDER THIS:

* A policy with a comparable lifetime no-lapse guarantee at your current age 65 would cost at least $20,000 per year. (Quotes received on insure.com for a policy with a comparable lifetime no-lapse guarantee.)

* The value being given up by surrendering the policy is $14,000 per year for life (new policy premium of $20,000 minus the old policy premium of $6,000).

* The cost to purchase an annuity with an annual payout of $14,000 per year for the rest of your life is approximately $180,000. (The cost of an annuity of $14,000 per year for the life of a man age 65 according to WebAnnuities.com.)

* Or alternatively, if the $180,000 were used to buy a single premium policy on your life, it would conservatively buy $330,000 of paid-up insurance. (Based on the 2001 CSO nonsmoker table and 4% interest.)

In other words, even if the policy did not provide any cash value, it has real economic value. Isn't it in the public's best interest to assure that reasonable nonforfeiture values are provided by insurance companies?

--Andy Ware

Andy Ware is vice president-actuary, FSA, MAAA, for Northwestern Mutual, Milwaukee, Wis. He can be reached via e-mail at andyware@northwesternmutual.com.
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Title Annotation:An Actuary's Opinion
Author:Ware, Andy
Publication:National Underwriter Life & Health
Geographic Code:1USA
Date:Oct 18, 2004
Words:1075
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