#193 | Nationwide’s Cap Change

Last week, Nationwide announced that it would be dropping caps on many of the S&P 500 accounts in its street Indexed UL products both past and present, including the standard point-to-point capped accounts that determine the illustrated rates for its products in accordance with AG49. I usually wouldn’t bother to write about a cap change, but there are just so many angles to what Nationwide did that it really shines a light on the how insurers are selectively and creatively dealing with an increasingly difficult earned rate and hedge cost environment. Nationwide is turning into something of a case-study on caps, whether they intended to be or not.

First, let’s start with a baseline interpretation of how Nationwide sets caps relative to many of its peers. The playbook most insurers are using to maintain aggressive caps is to essentially subsidize the cost of the cap through other policy charges or even, as bizarre as this sounds, pricing for interest rates to rise and therefore generate future profit to pay for today’s losses. From what I can tell, Nationwide doesn’t operate out of that playbook. Their products don’t have a lot of fat in the charges that can subsidize a high cap. Nationwide is also more reactive than most insurers to changes in earned rates or hedge costs, which means they’re probably not banking on future profits to cover today’s losses. Taken together, this means that Nationwide is a pretty good barometer of the core economics of Indexed UL caps these days and where other insurers will likely go in the future as their strategies of subsidization or assumed future profits bump up against real illustration actuary certification limits.

However, that does not mean that Nationwide’s recently announced cap rates are necessarily comparable to other insurers’ rates. Nationwide’s newer products have an embedded 15% Index Credit Multiplier automatically built into the account, which means the new 8.25% cap is functionally equivalent to a 9.25% cap. Nationwide’s caps on its older products that offer accounts without the 15% multiplier bear this out – YourLife Accumulator’s cap dropped from 10.5% to 9.5%. If you just look at the headline rate for the current street products, you’ll probably react the way that I did, which was an audible gasp at a 8.25% cap. But that’s not the real story. Nationwide is actually offering something more in the neighborhood of 9.25%, which isn’t the top of the market but not the bottom of the market either.

Now, for the interesting part about the announcement. Nationwide selectively dropped caps on certain accounts. In Accumulator II, the current street product, the only two caps to come down were on the benchmark point-to-point S&P 500 capped option and the long-suffering multi-index monthly cap option. The rest of the accounts remained the same. Why and how Nationwide managed to pull that off is what makes their move so interesting. Let’s say that Nationwide’s option budget dropped by 0.25%, which corresponds to a change from a 9.25% cap to an 8.25% cap. You would expect that all of the other accounts would change – but that didn’t happen. There are lots of reasons why and I’m going to speculate at will because why Nationwide actually did what they did is irrelevant. All of the strategies I’m about to mention are ways that carriers can, will and are already using to manage their caps in a very challenging environment.

First, let’s look at the amount of “wiggle room” in the pricing of the different accounts. For the two accounts with cap changes, wiggle room is minimal. These are very straightforward accounts with clear option budgets and clear (and fairly consistent) hedge costs. That’s not the case with the other accounts. Take, for example, the account that has a spread (but no cap) on the S&P 500 currently set at 5% and did not change with the recent announcement. Spread pricing inherently bounces around far more often and with far more volatility than cap pricing. Therefore, a decrease in the option budget doesn’t necessarily mean that Nationwide increases the spread for this account because spread prices are always moving anyway. For the accounts with asset-based charges, Nationwide is trading slightly different option strategies than the base accounts. Using an asset-based charge to buy a higher cap (8.25% to 13%, in this case) means that the price of the options for the normal cap and high cap don’t move at the same level or same amount. Again, there’s more wiggle room in this account than a normal account.

But the most interesting one, by far, is the Advanced Multiplier, which has a current 2.25% asset charge to buy a 50% multiplier. Nationwide is explicitly pricing the Advanced Multiplier off of a 4.5% option budget (2.25% / 0.5 = 4.5%), but we know that Nationwide’s overall option budget dropped by about 0.25% based on what they did in the base accounts. If they forced the Advanced Multiplier formula to recognize the change in the option budget, then the multiplier would have increased to about 53% or the asset charge could have dropped to about 2.12%. But neither of those things happened. So where’s the extra margin going? You guessed it – maintaining the cap at 9.25%. That’s the magic of the way Nationwide set up this account. When their option budget falls, they get subsidization for the cap. On the flip side, however, rising rates means more pressure on caps with the Advanced Multiplier than those without.

Another option is that Nationwide decided to subsidize the rates in the other accounts by dropping the rates on the two no-charge accounts with caps. Why would they make that choice? Let’s speculate. Perhaps certain parts of their distribution really, really like the buy-up cap story and they didn’t want to lose ground there. Perhaps they realize that they’re being spreadsheeted at the BGAs based on the income out of their Advanced Multiplier accounts, so they needed to maintain their ground there as well. It’s also possible that Nationwide has really been pushing the story with their spread S&P 500 account and wanted to make sure that account stayed robust. The beautiful thing about pricing is that all of these sales stories can be subsidized with the fact that people actually just choose the base accounts when they make their final allocations, but all of Nationwide’s key competitive angles revolve around the accounts that were not affected. And we also know that Nationwide has a predilection for doing this kind of cross-subsidization because that’s exactly what they’re doing in the New Heights IUL product, which was suspiciously unaffected by rate changes.

And finally, Nationwide might have just decided that bigger rate drops on selective accounts was a superior strategy than smaller rate drops across all accounts. Eanie-meanie-miney-mo.

Regardless of what Nationwide’s actual rationale was, the reality is that more and more life insurers are going to be employing creative strategies for managing both the financial and marketing impacts of today’s challenging environment. I suspect that most life insurers will shoot for an announcement like Nationwide’s where some rates drop and others stay stable. If you’re a producer, think of it like giving you a roadmap for which accounts are priced more advantageously than they should be and take advantage of that. If Nationwide wants to give you a 13% cap in the high-cap account for a mere 1% charge, then your clients should probably allocate to that and not the base S&P 500 accounts, at least not in Nationwide’s product.