#228 | Lincoln VULone & Prudential VUL Protector Review – Part 2
Why would these two products – Prudential Protector VUL and Lincoln VULone – have such different cash value profiles? If you’re thinking about Guaranteed VUL as if it was a Guaranteed UL, this doesn’t make a lot of sense. Everyone knows that cash value in Guaranteed UL is basically irrelevant to both the sale and for pricing. In Guaranteed UL, the insurer’s cash flow to support the guarantee is equal to premiums paid. If a client pays a $100,000 single premium, the entirety of that premium is set aside to support the guaranteed death benefit and the cash value, if there is any, is a pale reflection of the actual reserve set aside to support the product.
But in Guaranteed VUL, cash value is everything. That same $100,000 in a Guaranteed VUL would be placed into the separate accounts, which is the client’s money, not the life insurer’s. The only receipts to the insurance company are the policy charges deducted against the account value over time. Pricing Guaranteed VUL is therefore a balancing act between growing the cash value, which will offset the liability of the secondary guarantee, and assessing sufficient policy charges to cover the cost of the policy and the risk of the guarantee. Cash value is therefore the essential tool in pricing a Guaranteed VUL product because everything flows out of it. You might even go so far as to say that the premium requirement is a secondary function of the cash value – it simply seeds the initial cash value with a sufficient amount to balance policy charges and cash value growth.
As we’ve already seen, these two products have very different cash value profiles. Whereas Lincoln hamstrings cash value from day one with a 10% premium load, 0.9% M&E for the first 10 years and relatively high COI charges throughout, Prudential practically goes out of its way to grow cash value by offering a 0.4% interest bonus after year 10 and ultimate COI charges that are low and lapse-supported. The long-term difference is stark. Take a look again at the cash value profiles of the two products for a 45 year old Preferred Male using the same $165k premium and 6% return assumption.
From a client’s standpoint, both policies pay the same guaranteed death benefit. But from a life insurer’s standpoint, these are two very different products. Think about it this way – if the client were to die at age 100 in the scenario above, who pays the death benefit? In Lincoln’s product, Lincoln pays the death benefit. The account value lapsed at age 95 and Lincoln had the distinct displeasure of funding the value of the guaranteed death benefit out of its own pocket for the remainder of the client’s life, should they live past 95. In Prudential’s product, the client pays the death benefit with the account value. To put it in option terms, the guaranteed death benefit put option that Lincoln sold expired in the money whereas the same put option that Prudential sold expired worthless. The put options that Lincoln sells are more valuable, theoretically, because cash value is more likely to lapse than in Prudential. No surprise, the put option for Lincoln is also more expensive in terms of policy charges. Take a look at the policy charge receipts for the two products over time.
In this scenario, Prudential certainly still appears to get the better end of the bargain because they charged for a benefit that ultimately didn’t pay out. But unlike with options, price and value here are not disconnected – Lincoln’s put option is more valuable precisely because it is more expensive. On a net present value basis using an 8% discount rate (not abnormal for a stock company), the NPV of charges for Lincoln is $120,995 and just $84,009 for Prudential – but, again, in this case Prudential essentially didn’t have to pay a death benefit. This scenario would be extremely profitable for Prudential and marginally profitable, at best, for Lincoln. But what happens under different return assumptions? Take a look at the exact same analysis but this time at a 5% level return assumption.
In this scenario, both policies lapse before age 100, with Lincoln lapsing at age 86 and Prudential at age 91. Both put options will likely expire fully or at least partially in the money. The NPV of policy charges to age 100 is $111,540 for Lincoln and $95,544 for Prudential. You’ll notice that Lincoln’s NPV of charges decreased whereas Prudential’s actually increased relative to the 6% scenario. In Lincoln’s case, the policy lapsed earlier and therefore Lincoln was deprived of policy charges that it earned in the 6% scenario. For Prudential, the opposite occurred – when the policy lapsed, it generated more net amount at risk and therefore deducted more policy charges than in the 6% scenario without a lapse. Who was the winner on this deal? That depends on exactly when the client died, but in general Lincoln is better positioned to recoup more (and earlier) policy charges than Prudential despite the fact that both insurers are ultimately stuck with the same liability. What about at 7%? Take a look.
At 7%, the clear and unambiguous winner in terms of profitability is Lincoln, with significantly higher policy charges (NPV of $112k versus $85k) and a corridor death benefit just like Prudential. These 3 scenarios paint a complete picture of the possibilities for how these two products will compare over time – both lapse, both hit corridor or one lapses while the other hits corridor. In the examples above, both lapse at 5%, both hit corridor at 7% and at VULone lapses and VUL Protector hits corridor at 6%. For 2 out of the 3 scenarios, Lincoln is clearly the more profitable of the two products and only between 5% and 7%, it appears, does VUL Protector generate a better tradeoff for profitability.
However, this is an incomplete picture. For the examples above, I used the same $165k premium for both products. That’s obviously not how the products are actually priced. Before the recent repricing, VULone’s single premium solve for a 45 year old Preferred Male was $153k. Now it’s $179k. Prudential’s premium for this same cell is $167k. Each one of these premiums, therefore, drives a different return required for the cash value to hit corridor. As premiums go up, the corridor return assumption goes down. A price adjustment on a Guaranteed VUL policy is really a corridor rate adjustment, as you can see in the table below.
|VULone – Previous
|VULone – Current
This table puts Lincoln’s price changes into a different context. Although the declared price for the 45 year old increased by nearly 20%, what Lincoln was actually accomplishing was a reduction in the corridor rate from 6.75% to 6.15% without reducing policy charges. This is the key difference between VUL Protector and VULone. VUL Protector has lower hurdle rates for corridor (5.75% in this scenario) because it has lower policy charges. VULone reduced the hurdle rates by increasing the required premium. Both policies will over-endow at 6.15%, but VULone will be much more profitable than VUL Protector. On the flip side, both policies will lapse their cash value and put the guarantee in the money at 5.5%, but VULone will be much more profitable than VUL Protector.
No matter what way you cut it, the range where VUL Protector is more profitable than VULone is pretty small – usually 1% or less. I ended the last article with a suggestion that, perhaps, Lincoln knows something Prudential doesn’t. What I think they know is that from the standpoint of profitability, it’s better to have high policy charges than low policy charges, low cash value than high cash value in a Guaranteed VUL product. How does Lincoln know this? Because VULone started out as a low charge, high cash value Guaranteed VUL product. The early renditions of VULone had significantly better cash value than the current policy. Over time, Lincoln gradually chipped away at the cash value, which assuredly increased the profitability of the product. Prudential VUL Protector looks a lot like VULone circa 2012. I actually managed to dig up a 2012 VULone illustration and take a look at how the two products compare at 6%.
The late-duration drop in performance for VULone is due to higher COI charges, which basically haven’t changed from the current product. What has changed, however, are the premium loads (7% to 10%), the M&E in the first 10 years (0.6% to 0.9%), the fixed charges ($25,000 to $35,000 over 10 years), the policy fee ($120 to $180) and, finally, the guaranteed persistency credit in years 20+ (0.15% to 0.01%, although the current remains at 0.15%). So, basically, everything else. Lincoln has made a concerted effort over time to cut back on cash value in VULone even as it lowered guaranteed premiums. The two things are connected. In order for Lincoln to make the most out of the Guaranteed VUL chassis – namely, the fact that the subaccount performance can bail out the guarantee – policy charges had to increase, which helps to hedge off the downside risk by collecting more charges earlier and increasing profitability in the best-case performance scenario. Forgive the pun, but that seems like a prudent way to price the product.
Ironically, Prudential is charting a different course. VUL Protector is pure-bred to rely on subaccount performance. The guarantee is priced so that it needs to be bailed out and the cash value is tuned to make sure that happens at even moderate equity growth rates, depending on the premium and cell. I also managed to scrounge up an old VUL Protector illustration and, believe it or not, but the current VUL Protector is more tuned for cash value than the old one. Whereas Lincoln has ramped up charges, Prudential has decreased them across the board and even bumped up the persistency credit in the earlier years. The two philosophies on how to price Guaranteed VUL couldn’t be more different.
Which one is more sustainable? What’s the true value of the embedded put option? To answer these questions, we have step out of the static world of the level rate illustration and move into the real-world of variable returns. This will help us answer the question that everyone has been asking me recently – is Prudential’s pricing sustainable? We shall see.