#142 | Securian Cap Reduction

Back in 2008, Minnesota Life was just a sleepy little life insurance company in St. Paul, Minnesota. Its general account life insurance reserves were just $2.7B and it primarily distributed products through an exclusive BGA network. But then, Minnesota Life rolled out Eclipse IUL, which sported a 17% cap and illustrated rate of 9.5%. Sales took off and Minnesota Life has been near the top of the industry IUL charts ever since. At the end of 2017, Minnesota Life had grown to just under $8B in Life reserves. To put this in a broader perspective, Life is the source of more than 65% of the reserve growth at the company since 2008 and arguably 95%+ of the value created because the remainder of the reserve growth came from group annuities. And since the financial statements for Securian Financial and Minnesota Life are basically identical, one could argue that the rise of Securian Financial is inexorably linked to the rise of Minnesota Life, which is inexorably linked to the success of Eclipse IUL, which was undoubtedly due to having some of the highest caps in the industry.

I say all of this to point out the fact that caps are an existential issue for Minnesota Life. High caps are the way Minnesota Life carved out a commanding share of the fastest growing market in life insurance. So how did they do it? Minnesota Life got into the Indexed UL game with a few ways to get an edge. First, it was small enough and growing slowly enough in other Life lines that it could reasonably carve off some high performing assets to dedicate to the new Indexed UL product launch. Second, Minnesota Life credited indexed interest only to the end of year account value, which meant that it had to buy less notional (because policy charges eat up account value throughout the year) and therefore could have a higher cap as long as charges made up a large percentage of the account value, as they do in the first few policy years.

But the biggest place Minnesota Life saw an edge was by looking at hedging rather differently than most of their peers. As I’ve noted in other pieces, option prices bounce around quite a bit. Most companies set their caps with a pricing buffer so that they can maintain them for 6 months or a year even if option prices move against them.  Minnesota Life stripped out the buffer and, as a result, their caps were quite a bit higher than their peers. How do I know that Minnesota Life did that? Well, they certainly didn’t tell me, but you can see it clear as day when you compare what they’ve actually paid for options over time and how they’ve changed their cap. Take a look at the chart below.

Every time option prices spiked, Minnesota Life dropped its cap. Put another way, there are no spikes on this chart that do not result in a cap reduction at Minnesota Life – from 16% in 2009, when they started using call options to directly hedge, all the way down to the 10.5% cap announced a couple of weeks ago. Minnesota Life was clearly running on the ragged edge and the moment the trade turned against them, they changed the cap to limit the damage. But there’s more going on than even that. The two other tricks they had up their sleeve – high yields and end-of-year crediting – were inevitably short term benefits. The more new premium came in the door, the faster the yields got diluted. The longer policies stayed on the books, the less charges were compared to the account value and the more notional they had to buy. It was only a matter of time before caps inevitably came down, even if option prices had cooperated (which they arguably did for a long time).

Commendably, Minnesota Life didn’t play bait-and-switch with new vs. in-force caps. If you think about it, those two tactics of using higher yields and end-of-year crediting work any time you fire up a new block of policies. Minnesota Life could have kept starting new policy series and illustrating high caps for new policies while letting in-force caps fall, but they didn’t. They kept the same cap for every policy on their books. Despite the fact that the cap as been falling since 2008 and didn’t go up when option prices cratered in 2013 and 2014, the consistency of caps across their block is noteworthy.

So what is Minnesota Life to do now? They’re in a tough spot. Through Q3 of this year, their sales have stalled out while most of their competitors have gobbled up marketshare. It certainly isn’t due to a limited product portfolio – Minnesota Life has been prolific in rolling out new products over the last few years and have a credible product in almost every category. They also recently added leveraged accounts with an asset-based charge and Index Return Multiplier (IRM) to their flagship Orion IUL. But the bigger issue for Minnesota Life is this – what are they if not the company that has the highest caps? Well, I suppose we’re going to find out.