Assessing the Strength of Insurers

Look beyond the surface of life policy guarantees to see how a carrier is backing them

By Alan S. (Al) Lurty

If you sell life insurance products that feature certain guarantees, you might be noticing unusual behaviors from the carriers who offer these products. Some might be signaling a reduced appetite for selling these guaranteed products by raising prices, while others may have stopped selling certain guarantees altogether.

This may be surprising since many of the most popular insurance policies these days have premium guarantees that are fairly long. The guaranteed level term policy, for example, often comes in 10-, 15-, 20- and 30-year versions. Also popular is the secondary guarantee universal life policy (SGUL), where the insured enjoys level premiums for, in some cases, his or her entire lifetime. Beyond these attractive guarantees, SGUL plans are very flexible, and can be based on a traditional universal life chassis, an indexed chassis, or a variable universal life chassis.

As attractive as these premium guarantees are, they come with strings attached for the carriers – a link to prevailing interest rates. Several years of historically low interest rates, and the prospect of at least two more years of rates at roughly the same level, also put a great deal of pressure on carriers. They are struggling to balance conflicting demands: to support the guaranteed premiums of certain life products they’ve issued, to sustain the right level of reserves to cover obligations, and to continue to meet shareholder expectations.

The technical term for this kind of pressure on carriers is “capital strain” and producers in today’s environment should understand this phenomenon. By tuning in to the way carriers are responding to capital strain, producers can both keep their businesses running efficiently and ensure that the death benefits on clients’ policies will be in secure hands in the event that payouts might be needed several decades from now.

How capital strain occurs

Here is a brief overview of how capital strain builds up for a carrier in the course of issuing guaranteed policies.

The carrier issues a guaranteed premium policy; the costs of acquisition, commissions, and other expenses typically are higher than the first-year premium.

This gap between premium and expenses causes the carrier to incur a first-year loss under statutory accounting rules.

This loss, when added to the requirement for more reserves and risk-based capital to cover the writing of the product, can actually add up to several multiples of the premium. Why? Because the issuer must set up “redundant” reserves for products with long-term guarantees that are far greater than pure economics would demand. Over time, these reserves can rise to seven or eight times the initial premium before declining in later years.

To cover the initial loss, the carrier must draw from profits on existing in-force business, or request capital from its corporate parent or other source.

As a consequence, the carrier is limited in how much it can pay as dividends to the parent or to shareholders.

In the past, some carriers have used capital methods, including bank letters of credit, to finance reserves and ease capital strain. Unfortunately for the carriers, their pricing often had baked-in assumptions that mid- and long-term interest rates would rise over time. Instead, rates have been very low, and it’s likely that they’ll remain that way at least into 2014. Since they can’t invest premiums at the assumed returns, carriers have had to set up “economic reserves” to address the low interest rate environment. These economic reserves, added to the redundant reserves driven by state regulations, create further capital strain.

Impact on Producers
Not surprisingly, carriers are responding to these pressures in ways that producers are feeling every day. Some carriers are raising prices on guaranteed life products, particularly SGUL types, significantly. Others are trying to emphasize other products, such as accumulation-focused or indexed universal types, that do not produce as much capital strain as products with long-term guarantees. These actions can spill over into other product areas, which is why some producers may also be seeing rising rates for term life insurance, especially for plans with the longest terms.

Producers are put in a challenging position by carriers’ shifting priorities and pricing. They have cultivated relationships with carriers to gain access to reliable markets for the guarantees their clients find attractive. With those markets and pricing in flux, producers must devote more time to finding the most favorable rates for clients, while worrying whether a carrier might suddenly pull back from issuing the policy.

If a carrier’s capital constraints causes it to stop offering popular guarantees, the producer has to analyze offerings of competing carriers, form new relationships with those carriers’ marketing staff, and learn the machinery behind the products themselves, since they often have slightly varying provisions, calculations, conversion rules, and other nuances. Producers would much rather spend their valuable time serving clients.

Producers who understand how insurer guarantees and interest rates are connected will be better able to guide clients through an ever-shifting product landscape. To gauge a carrier’s capital strength, producers can look at the carrier’s risk-based capital (RBC) ratio, which is a company’s total capital divided by its risk-based capital, which accounts for investment risks and operations. You can find the data to derive the RBC ratio by looking at insurers’ annual statutory financial reports, which usually are available on their websites.  By performing this important due diligence you will be in a better position to go the extra mile for your clients by assessing their product options across carriers.