Turning the table: the 2001 mortality table promises to spawn new life product designs.
"Adoption by 26 states defines the table as a prevailing mortality standard for federal income tax purposes;' said Lloyd Spencer, head of Client Product Solutions for ING Re's Individual Life & Health Operation. The U.S. Treasury Department has rules on how much insurers can deduct for income tax purposes, and the rules provide for a three-year transition period once 26 states have adopted the new table.
The 2001 CSO Mortality Table was developed through the joint efforts of the Society of Actuaries and the American-Academy of Actuaries. The National Association of Insurance Commissioners reviewed the work and adopted the table in December 2002. The new table reflects improving longevity and assumes insureds will die by age 120. The earlier CSO table, established in 1980, had a cutoff of age 100. As a result, the 2001 version drastically reduces the reserves insurers will be required to hold, thus granting them the opportunity to redesign products and to reduce premiums.
Since the primary driver for universal life and variable universal life will be the federal income tax impact of the 2001 CSO, there remain some open questions, Spencer said. "The IRS is still working through issues in terms of how the implementation of the new table will impact some of their additional tax regulations on the U.S. life insurance industry," he said. "So the industry is waiting to see where that ultimately will fall out. This will be an interesting story that will develop over the next two to three years."
The industry's trade association, the American Council of Life Insurers, has been working with the Internal Revenue Service on those tax ramifications, said Laurie Lewis, vice president and chief counsel, federal taxes, for the ACLI. Two aspects of the table are relevant for tax purposes, one from the insurance company side, which is more straightforward, and the other from the policyholder side, which is more challenging, she said.
Under IRS Code, it falls to the insurer to determine how much of its reserves will be tax deductible, based, in part, on what mortality table is used, Lewis said. "We don't really have any pending questions on this," she said. "It's just something that companies are addressing and dealing with."
But the IRS Code places both annual and overall limits on how much premium policyholders can pay into their policy relative to their death benefits. "For example, you can't have a policy that has a $1 million death benefit and $1 million cash value," Lewis said. "There are limits on how much your cash value growth can be relative to your death benefit. And part of the way that you determine what those limits are is based on what your mortality charges are."
Currently, nothing in the IRS Code definitely dictates what to do when the mortality table is changed regarding life insurance products, although there are rules regarding reserves, she said. While insurers face few open questions on the reserve issue, they encounter a void on the product side as to when they must change product designs, or do things differently according to how much premium a policyholder can pay into a policy, Lewis said.
"It's not as simple as telling someone, 'OK, today milk is going to cost $1 and yesterday it cost 90 cents,'" she said. "The amount of premium you pay goes into the policy design, especially on a traditional policy because you know you have a fixed premium often for the life of the contract. So it's a very complicated procedure to determine what effect the new table is going to have on this premium computation."
In November 2002, the ACLI sent the IRS a proposal on tax issues and the new CSO table. Discussions were held, but there was no sense of immediacy, Lewis said. With the 2001 table adopted for use in 32 states, however, and insurers now able to use this table in those locales, the problem becomes much bigger because insurers need to carry out policy design for the next generation of contracts, she said.
On the product side, the ACLI wants the IRS to give insurers the option of staying with the 1980 table until they must begin using the new one as of Jan. 1, 2009, the deadline cited in the NAIC model regulation for adoption by all states. "It's now a situation where your tax reserves are going to have to be computed using the new table," Lewis said. "You don't want to have a mismatch between your tax reserves and your statutory reserves."
The IRS should require those insurers that have already chosen to use the new table in policy design--computing, for example, nonforfeiture rates or other contract rates--to compute their tax limitation using the new table as well, Lewis said.
"Does that mean that there are going to be companies in December 2008 still selling products using the 1980 CSO? I don't know that they will or won't from a tax perspective," Lewis said. "I think what will drive that decision more will be a marketing perspective because there are advantages to the new table and there are advantages to the old table. So it's going to depend on what kind of product design you have and what the needs of the consumer are."
With 32 states in line, Lewis is optimistic that the IRS will move faster now. "We need to have this certainty of what we're going to do on our policy design. We need to know that 100% of the new table will be able to be used in the policy design phase," she said.
A few companies have already seized the competitive advantage in the term-life product line by lowering rates, including USAA Life Insurance Co., San Antonio, and Savings Bank Life Insurance Company of Massachusetts, Woburn, Mass. Texas and Massachusetts were among the first 21 states to adopt the new mortality table.
SBLI's term-life rate cuts averaged about 15%, but ranged from 3% to 49%, depending on the prospect's age and underwriting. About 75% of SBLI's business is in its home state, but the company sells in 12 states in the Northeast and as far south as Virginia.
USAA's rate reductions range from 10% to 30% and are available to USAA members in 39 states and the District of Columbia. USAA Life is a wholly owned subsidiary of United Services Automobile Association, a reciprocal interinsurance exchange serving members of the military.
The 2001 CSO table promises to spawn new product designs. Some insurers will update their term portfolio first, and then move through the rest of their product offerings to address whole life, universal life and variable universal life, Spencer said.
"What we're observing is a phased approach from the industry--not all life insurance products are created equal in terms of complexity," he said. "From an actuarial standpoint, updating your level premium term portfolio is a much more straightforward process. For term life, a number of companies are evaluating the optimal timing for implementing a change to their product offerings."
As a life reinsurer, ING Re has been asked by a number of clients in recent months to evaluate their products on both a 1980 CSO as well as a 2001 CSO basis. "But the vast majority of companies are moving forward with the 2001 CSO basis as their valuation standard," Spencer said. "That gives them the maximum flexibility to hold their prices constant and also enables them to use the most current mortality standard."
Typically, direct writers face a three-month product development cycle. To that end, ING Re also offers its clients product development services. "We have updated two clients' portfolios over the past few months to reflect the 2001 CSO on their behalf," Spencer said. "It's a customized approach that we can offer clients to quickly get up to speed in the marketplace when they are pressed for time or short on staff resources."
Over time, insurers are expected to update their more complex offerings, such as variable universal life or universal life, he said. But tax considerations have prompted companies to delay work in these areas. "This is related primarily to the premium that the policyholder is allowed to deposit into the contract and have it still qualify as life insurance from an income tax standpoint," Spencer said.
"In terms of more complex life insurance product offerings, like variable universal life or universal life, it's really coming to grips with the tax issues that will make companies take this slower, wait-and-see approach to see how quickly the market moves to the 2001 CSO," he said." A number of those products are cash value, accumulation-type products where part of the motivation for the purchase is an investment return. And the 2001 CSO will put pressure on policyholders' ability to fund those contracts at the same level as they've funded them in the past." That's the primary limitation that direct writers will be looking at with those contracts, he noted.
The Role of Reinsurance
During the past year, individual life insurance and reinsurance markets have begun to harden. Interest rates are at historical lows, surplus relief costs for reinsurers have been rising over the past few years and reinsurers have limited the rate of future mortality improvement assumed to occur in their pricing. As a result many direct writers have seen reinsurance prices bottom out over the past two to three years, he said. "One barrier to moving forward at full speed on any update of a product portfolio is that direct writers are aware that reinsurers are no longer in a position to offer ever-decreasing reinsurance costs to them when they submit their new products for a reinsurance quote," he said. "So they are having to balance the competing priorities, implementing a current table but also realizing that their net reinsurance costs will be certainly no lower than they were before."
Over the past 10 years, reinsurance costs continued to drop in spite of consolidation among life reinsurers. These lower costs have been driven by the significant increase in direct writers' use of quota-share reinsurance and by reinsurers' pricing mortality assumptions that continue to reflect improved U.S. mortality, especially among insured lives, Spencer said.
The 2001 CSO table will lower an insurer's reserves to pay for future mortality costs. These companies are charging a level premium, but mortality costs will escalate over the pricing horizon, Spencer said.
States That Adopted the New Mortality Table
As of Sept. 1, 2004, 32 states had adopted the use of the 2001 Commissioners Standard Ordinary Table or a similar model. The table became prevailing for federal income tax purposes on July 1, 2004.
Note: Effective date is when the law goes into the books. Permissive date is the first date on which a company can use, if it chooses, the new tables when calculating reserves on new policies. Must date is when companies have to use the new tables. Mostly, according to the state laws, this is late 2008 or Jan. 1, 2009.
Source: American Council of Life Insurers, ING Re
* The new mortality table reflects improving longevity and assumes insureds will die by age 120, or 20 years beyond the cutoff established in the 1980 table.
* The 2001 table drastically reduces the reserves insurers will be required to hold, thus granting them the opportunity to redesign products and to reduce premiums.
* The American Council of Life Insurers has been working with the Internal Revenue Service to address tax issues for the life industry in using the new mortality table.
A.M. Best Company # 07029 (Security Life of Denver Insurance Co.)
Distribution: Internet, call centers, intermediaries, banks
Savings Bank Life Insurance Company of Massachusetts
A.M. Best Company # 06696
Distribution: Direct mail, telemarketing, banks
USAA Life Insurance Co.
A.M. Best Company # 07146
Distribution: Direct sales
For ratings and other financial strength information about these companies, visit www.ambest.com.
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|Title Annotation:||New Products|
|Comment:||Turning the table: the 2001 mortality table promises to spawn new life product designs.(New Products)|
|Date:||Oct 1, 2004|
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