Issues Impacting Life Insurance Sales
Potential buyers of life insurance must make many decisions when selecting policies appropriate for them. Currently complicated outside factors are influencing their thinking and may be affecting purchases. These factors are low interest rates, the pending reduction of the estate/gift tax exemption, and the reserve requirements in Actuarial Guideline 38 (AG 38) and Europe’s Solvency II. All are related to government and regulatory action or inaction.
Low Interest Rates
Consumers know how little interest is being paid on savings by banks and they are probably aware the Federal Reserve is keeping interest rates down. Low interest rates also impact insurance companies, but “I don’t think consumers generally view life insurance products as interest sensitive or ‘spread sensitive’ products,” noted Christopher (Chris) Greis, President and Founder of Leaders Partners, Inc. “And I would guess consumers have no clue of the kind of stress life insurers are under in this interest rate environment. Agents and advisors should be reminding clients during annual reviews that our products are fi nancial instruments and as such are subject to change.”
“The consumer is constantly instructed by the so called experts that low interest rates are good for the economy,” said Leon Huffman, CEO of The Brokers Network. “We are told with low rates the housing market can recover, equity investments are more attractive so we create wealth, and we can create an environment for business creation and expansion. The negative impact of low rates on savings and protection is rarely discussed. People who want to save money and put it where there is no exposure to loss of value must accept very low yields.”
With life insurance policies, product pricing assumes an interest component in the way reserves are set aside and grow, Greis explained. If super low interest rates are allowed to persist artifi cially over a prolonged period, these pricing assumptions are stressed, Huffman said.
“When current investment returns fall and, worse, as insurer portfolio rates fall, spreads are challenged and can even become negative,” Greis pointed out. In mid-2012, insurer portfolio yields were averaging about 5 percent and current investment yields were closer to 4 percent. At these rates, insurer interest assumptions are severely challenged. The result has been widespread product repricings.
Product pricing is driven by interest rates. “Risk products like term life and long term care insurance depend on interest rates at certain ‘floor’ levels for long term profitability,” said Greis. “Spread products like whole life and universal life assume interest rates at certain levels for reserve purposes and resulting cash value growth. Interest rates affect crediting in universal life plans and dividends in whole life plans. Interest rates also dictate the efficacy in surplus uses, especially when surplus is deployed in product reserving. A falling or a sustained low interest rate environment impacts product profitability on the carrier side and product performance on the consumer side.”
“Sustained low interest rates will continue to lead to higher premiums, lower guarantees, poorer performance, and the elimination of products,” Huffman emphasized. Products with pricing most sensitive to interest rate assumptions are the ones most affected. Products with long term guarantees of either cash or benefits are most impacted by prolonged low interest rates, while products with fewer or short term guarantees will fare better. “Products with accumulation rates not linked directly to bond yields, like indexed products, offer an attractive alternative, which is part of the reason we see growth in these products,” he added.
Pending Gift/Estate Tax Exemption Reduction
If Congress does nothing, which is possible considering their continuing inaction, the gift and estate tax exemption allowing the transfer of wealth tax free will decline from $5.12 million per person to $1 million on January 1, 2013. The issue could be addressed in the post-election lame duck session or in a retroactive law passed after the new Congress takes office or not at all. The threat of this large exemption reduction could motivate wealthy consumers to buy more life insurance since life insurance proceeds pass free of federal tax.
People with these large estates are aware of the pending change as well as the uncertainty surrounding it. Some may be considering additional life insurance purchases as a result. “With so much uncertainty and people’s natural inclination to wait and see, I think we may see anything from a slight increase in sales to a fi re sale at the end of this year,” Huffman said.
There is recent historical precedent regarding changes to this tax exemption. Some of the same people may have begun procrastinating in 2000 when the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) declared estate tax rates gradually reducing over the following decade, reverting to the pre-EGTRRA levels in 2011, Greis pointed out. Those levels were a punitive 55 percent estate tax rate over an exclusion of $1 million.
“The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRA 2010) postponed the reversion to pre-EGTRRA levels for two years, which means 2013 will look like 2000 for estate tax purposes unless Congress intervenes,” Greis noted. “While there seems to be some consensus that the 2009 levels (45 percent tax rate and a $3.5 million exclusion) represent a good place to compromise, and leaders in both the Senate
and the administration have suggested these levels, any compromise will take serious negotiation between Congress and the White House and between Republicans and Democrats.”
Producers can use the power of the fi nancial leverage of life insurance as a selling point. “A gift to an ILIT that fi nds its way into a life insurance policy can provide untaxed liquidity for pennies on the dollar,” Huffman noted. “The super wealthy are continuing to plan and to take action. I am not sure if couples with estates over $10.2 million are any more motivated by the complete uncertainty of estate and gift taxes. At what estate level are people motivated? That depends on what they know and what they believe might happen. People make the best decisions when the consequences of their decisions are clear. If we don’t know what the estate, income, capital gains, or dividend taxes will be in a few months, how can you plan? Uncertainty is a sales killer.”
“The tragedy is people continue to procrastinate while people are dying and estate taxes become payable,” Greis said. “We recommend planners consider the 2009 estate tax regime as a good assumption for estate tax planning purposes. Life insurance is the best leverage tool available for addressing these estate tax needs, and clients who fail to plan do so at their peril.”
AG 38 and Solvency II
AG 38 in the U.S. and Solvency II in Europe are government regulations setting the reserve amount insurance companies must hold. Both mandate larger reserves than previously required. These regulations are currently in flux and their interpretations may be clarified soon.
“Years ago the U.S. regulators agreed the reserve requirements were excessive,” Huffman explained. “Excessive reserves artificially increase the price of life insurance products without providing any real benefit to the consumer. Companies were promised that, in return for an agreement on the understanding of AG 38, they would be given a new set of rules that would allow a lower, more appropriate level of reserving.” He does not expect this to happen quickly.
Once issued, the new AG 38 guidelines should strengthen requirements for certain no lapse UL and term products and will probably take effect in early 2013, Greis explained. “The higher required reserve requirement will reduce profitability, which no carrier will tolerate, resulting in product re-pricing and/or withdrawal,” he said.
Solvency II strengthens capital requirements for European Union insurers and holding companies and will affect their U.S. subsidiaries if the EU does not see “equivalency” in U.S. capital requirements. It is expected to begin in 2014. While there is currently no direct effect on the U.S. insurance industry from this, “Prudential plc famously suggested they may re-domesticate from London to Hong Kong in the wake of Solvency II, and their U.S. subsidiary Jackson National has announced they are exiting the life insurance business, although this may not be connected to Solvency II,” Greis said.
These somewhat esoteric insurance reserve issues are unfamiliar to even affluent, educated consumers. In fact, people may have the misguided idea that “reserves are a good thing so increased reserves are even better,” Huffman said. “Any level of required reserves above what is necessary does not make the products or the company any safer. It only makes the products less available and more expensive. There is a pretty good argument that can be made that the financial engineering to put a portion of the redundant reserves back into surplus could make a company less safe than if the reserve requirement were only what is necessary.”
“Reserves are like high tides in the harbor, raising all boats anchored there,” said Greis. “Competitive advantage is what it is and is hopefully rooted in something beyond price. Relative product and carrier positioning pre or post a reserve requirement change should not change all that much.”
by Jay Feingold for the November/December 2012 issue of NAILBA’s Perspectives Magazine.