#225 | Making Sense of MassMutual’s Whole Life Price Increase

A couple of weeks ago, MassMutual announced that it would be increasing premiums on its Legacy 10 and Legacy 12 Pay products by about 10%, on average. The announcement went on to say that:

  1. Guaranteed cash values will not change
  2. Illustrated dividends will not change significantly in early years
  3. Illustrated early IRRs will be reduced
  4. Illustrated long-term IRRs will be similar to today
  5. All 10 Pay and 12 Pay products with LTCA will be MECs

It’s been quite interesting to see the various interpretations of this announcement, particularly from the field. Some folks seem to think that this price increase is similar to a price increase on a Guaranteed UL policy – that is, an unmitigated negative for the competitive position of the product. Other folks seem to think that this price change is an indicator of the dramatic pressure on carrier general account yields and a harbinger of a potentially drastic dividend decrease at MassMutual. Still others might shrug it off as a non-event because the long-term illustrated IRRs aren’t changing. The reality is that all of these interpretations have elements of truth, but the big story how they’re all tied together in a single product chassis – one that has stood the test of time precisely because it allows for adjustments like the one that MassMutual is making.

Let’s start with the price increase itself. As the press release mentions, the guaranteed cash values do not change as a result of the price increase, which is a function of how Whole Life is designed. No matter how the product is funded, the guaranteed cash value has to ultimately endow the contract. The ultimate slope of the guaranteed cash values is a function of the guaranteed mortality table (a 2017 CSO table, in this case) and the 4% non-forfeiture valuation rate and policy expenses. For example, on a 50 year old Preferred male for a $1M DB, the year 40 guaranteed cash value is $801,390 regardless of whether the policy is a 10 Pay, 12 Pay, Pay to 65 or 20 Pay. That’s how Whole Life works. The guarantees are the guarantees are the guarantees – independent of how much the life insurer thinks it’s prudent to charge for those guarantees.

No matter what way you cut it, the guarantees in Whole Life look exceptionally rich these days and particularly for short pay products. On the same 50 year old specified before, the current 10 Pay product at MassMutual breaks even on a guaranteed basis by year 15 and produces a whopping 1.5% IRR on guaranteed cash value by year 30. Thirty year Treasuries are also yield 1.5%, but that’s without paying any commissions, life insurer overhead, premium taxes or carrying significant death benefit coverage for 30 years. All of these additional costs add up to about a 1% annual drag over 30 years, meaning that the effective yield for MassMutual to cover the guarantees is around 2.5%. That’s quite rich – and a 10% premium increase only blunts some of the damage, shaving about 0.4% off of the guaranteed cash value IRR in year 30. The 10 Pay is undoubtedly the richest in terms of guarantees, but the 12 Pay is no slouch either, posting 1.2% / 0.8% IRR on guaranteed cash values before / after the price increase.

The contrast between guaranteed cash value IRR in short pay and maturity pay products is stark. While the 10 Pay year 30 IRR is 1.5%, the Pay to 100 product posts a negative 1.8% IRR in the same year. Illustrated performance, however, doesn’t show the same huge difference in year 30 – 4.0% for the 10 Pay and 3.2% for the Pay to 100. Why is that? Look at the inputs to the guaranteed cash value formula relative to what’s actually priced into the product. Guaranteed COIs are significantly higher than current COIs. Same goes for policy expenses. But the interest credits aren’t that different – a 4% rate for the guarantees and maybe something like 5.5% for the policy itself. Therefore, the guarantees in a Pay to 100 product are going to be consistently dragged down by heavy guaranteed expenses with relatively little eligible to earn the 4% guaranteed rate. But in a short pay product, the equation flips the other direction and the 4% guaranteed rate overpowers the heavy expenses because there’s so much premium being paid early in the contract.

The problem is that life insurers find themselves somewhat caught between a rock and a hard place on how to set the guaranteed rate for the contract. Currently, valuation rates for reserving are at 3.5% and linked to bond yields. Rates for calculating nonforfeiture values are equal to 125% of the valuation rate with a hard floor of 4%, which is also the hard-coded value for 7702 calculations. The triangulation of these rates leads most insurers to use 4% as for their guaranteed cash values. And, as a result, all guaranteed cash values in Whole Life are incredibly rich. Companies are working behind the scenes with regulators to begin to remedy some of these formulaic challenges, but for now it’s pretty hard to argue that MassMutual wasn’t making a prudent move in increasing prices. And it’s also pretty hard to argue that other sellers of short pay Whole Life products won’t be following suit over the summer if Treasury rates stay where they are.

But the beauty of Whole Life is that a price increase doesn’t necessarily hurt the non-guaranteed performance of the product. Whole Life allows the life insurer to simultaneously reduce the risk of the product without harming performance if dividends turn out to be healthy. The two are not necessarily intertwined. Dividends are a function of the distributable earnings created by the product itself. An overfunded product has the potential to earn even more dividends which are (usually) then used to purchase Paid Up Additions, which themselves have guaranteed cash values and non-guaranteed dividends. It’s a virtuous cycle that is fueled by overfunding.

However, the fact that MassMutual didn’t increase dividends to offset the price increase is somewhat of an indicator of the fact that Mass is also hedging the non-guaranteed side of the policy. If today’s investment yields were strong, then theoretically Mass would have been able to plug some of the gap created by higher prices with dividends. But today’s investment yields are very low and, if Treasuries are any indicator, only going to get lower. Mass is building a bit of a buffer for low rates by charging higher premiums without an immediate bump in dividends. However, as the press release mentions, long-term IRRs are virtually identical before and after the price change. It’s as if MassMutual is holding on to the additional early premium just in case they need it and, if they don’t, they’ll release it back into the policy.

So what does this price change really mean? It means that a mutual company is making a smart and prudent move to reduce its exposure to interest rates while still delivering the same long-term performance if rates and investment yields stay healthy. It’s pretty hard to say this is a bad thing for clients considering that people who buy a Whole Life policy from a mutual company are directly invested in its long-term success. It’s also pretty hard to say that this has anything to do with what MassMutual is planning to do with its dividend because this move is more about long-term interest rate risk and less about short-term reinvestment risk, although it does signal the incredibly challenging environment for investing new money that will ultimately feed into the dividend. And, finally, the folks who shrug it off are also on to something because it’s not unlikely Mass won’t need the price increase and invested yields will be fine. The reality is that other companies will have to follow suit. By the time the market normalizes to ultra-low rates, all short pay products will likely be repriced to higher premiums than they are right now. These price changes shouldn’t be a deterrent for consumers but, instead, and indicator of the attractiveness of the sheer guarantees in a Whole Life product. And it’s hard to see why selling off of guarantees is a bad thing in any environment.