#40 | Unintended Consequences in GUL Administration

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My education in Guaranteed UL began long after I had helped place millions of dollars of GUL premium, run hundreds (thousands?) of GUL ledgers and given many presentations on creative designs using pricing holes in GUL products. The product, to me, was just the illustration. But I’ve learned over the past year that Guaranteed UL is anything but simple and that the illustration is only part of the story. Carriers were more than willing to bake excessive complexity into the products for a variety of reasons ranging from noble (pricing precision) to downright scandalous (cheating on AG38 reserves) and I began to see how that complexity could make GUL explosively unpredictable when the client did anything that wasn’t on the illustration. However, I was mostly stuck with conjecture. I’d heard a few horror stories but didn’t have any real evidence.

And then Nationwide did an audit of 8,100 in-force GUL policies. I should note that Nationwide has only been in the GUL business for 3-4 years and did not participate in the two-tier shadow account shenanigans. What Nationwide found is pretty startling – 31% of the policies were off track and the primary culprits were early payment (53%), skipped premium (29%) and insufficient payment (8%). There’s no reason to believe that Nationwide is systematically different from its peers, so the results are probably indicative of what’s happening at other carriers. Well, I take that back. Nationwide must be systematically different because they actually had the gumption to run an audit, alert policyholders, allow for a costless one-time fix and instate a system that automatically alerts agents and policyholders in the future to deviations from the planned premium pattern. Every other insurer should follow suit in short order. No excuses.

Nationwide’s results give us powerful insight into the frequency of administrative problems in Guaranteed UL. One of the reasons why Nationwide’s policies are off track if premiums are paid early is because Nationwide has different shadow account crediting rates at different funding levels. If you cross a funding level by paying early, your premium will accrue in the shadow account at a lower rate than if you’d paid on time. So one risk factor in GUL administration is any sort of premium load or crediting discrepancy at different funding levels.

The other risk factor has to do with the penalty for payment error. Shadow account structures are fairly unique and each will react differently to premium payment divergences, but a maxim generally holds – fixing a problem sooner is better than fixing it later. The only wrinkle to this story is what happens when the policy actually hits lapse pending status, which is actually pretty easy to do in some products. Products with a single shadow account cost curve will respond according to the maxim and the penalty will be large. Products with multiple shadow account cost curves, on the other hand, can generate catch up premiums usually on the order of 6-10 times the original premium in early years and more like half of the face amount in later years. So the other major risk factor in GUL administration is the presence of a two-tier shadow account structure.

Since I’ve started writing about this, many people have asked me to put together an exhaustive list of what carriers have products with these two risk factors. Below is my best effort, but I should caveat with a few comments. First, the contract is one thing and reality is another. Products that appear to be low-risk according to a quick read of the contract may have other provisions that cause problems. Second, I didn’t have a contract for some carriers, but I can tell you that Prudential and Protective both used multiple shadow accounts. Also, Transamerica told me that they did as well but I couldn’t find it in the contract (see point 1). Third, product design changed dramatically in 2006 as a result of a revision to AG 38. Prior to 2006, AG38 did not specify a premium load that should be applied to get to the shadow account value that determines the reserve. It’s not surprising, then, that carriers exploited the ambiguity of the language by applying 50%+ premium loads in order to reduce their reserves. Products prior to 2006 tend to have all sorts of funky load structures (see Principal’s 2005 policy below). After 2006, carriers switched to using two-tier shadow account cost structures to get around AG38. I included the dates of the policies I have because they signify what AG38 language was governing the policy and, by extension, how the carrier was cheating it in policy design.

The conclusion we can draw by looking at this data is sort of obvious – there’s a fair chance that a significant number of GUL policies are off-track and that the penalties for being off-track are probably going to be steep if they’re left unchecked.

Life insurers should do three things. First, they should conduct an audit of their policies and offer remediation solutions. Most carriers have dealt with GUL administration problems on a one-off basis, which is unacceptable given how widespread the problem is. Second, they should nullify all policy language that discusses a two-tier cost curve and change company policy to ignore charges associated with a two-tier structure. Carriers no longer get reserve relief for using two tiers, so they should just dump them. Third, carriers should change their administration practices to send notices to clients and producers about partial, skipped, early and late premium payments. The average producer obviously isn’t administering these policies, so carriers need to put stopgaps in place. Again, I applaud Nationwide for being proactive in measuring and dealing with this problem. Of course, I’m assuming that carriers actually want this business to stay on the books. Bad assumption? Maybe. It’s no secret that lapses on GUL products are profitable.

So where does this leave us? Collectively and individually, we’re massively exposed to administrative shortcomings in Guaranteed UL. We need to publicly discuss and deal with this issue before we end up on the wrong side of a class action lawsuit.

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