#336 | The Return of Guaranteed UL?

Quick Take

It’s tempting to think that rising rates will necessarily result in the return of cheap Guaranteed UL, but reality is a bit more complex. Cheap Guaranteed UL still exists because some companies remained willing to price under the assumption that interest rates will revert to the mean. As a result, it’s unlikely that the most competitive Guaranteed UL prices will drop, but there will be pockets where that happens – particularly short and single pay designs, which could result in a potentially ill-advised replacement rush for mature Whole Life policies. There may also be a few significant price moves and product reintroductions from companies that are pricing to fair market, particularly companies with affiliated field forces. But for companies with massive legacy Guaranteed UL blocks, the choice will likely be to stay out of the fray and continue to focus on Guaranteed VUL as the guaranteed chassis of choice – at least until rates come up another few hundred basis points and the in-force blocks start to show consistent profitability.

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As interest rates have skyrocketed in the past few months, I’ve increasingly heard hopeful speculations about the prospect of falling prices in rate-sensitive products with embedded guarantees – Guaranteed UL, Guaranteed VUL and even Term. And that would make sense, right? In 2009, life insurers under European and Canadian embedded value accounting swiftly repriced or closed out products with long-tail guarantees. There was a palpable rush for the exits. Since then, US insurers have begrudgingly followed suit as US economic and reserving regimes have shifted more towards fair value accounting. But with corporate bond yields touching levels we haven’t seen in over a decade, isn’t it time for companies to jump back into guarantees with both feet?

Since I got in the business in 2007, I’ve kept an eye on Guaranteed UL pricing for a particular cell – Male, 55, Preferred, $1M of death benefit. Competitive level pay premiums for that cell have consistently hovered around $12,500 with shockingly little variation over the past 15 years. The only thing that has changed constantly is the company offering the $12,500 premium.

To put that number into context, consider what kind of interest rate would have to be credited to a Universal Life policy with standard commissions, standard policy charges and mortality equal to 85% of the 2015 Preferred VBT*, a reasonable (if not somewhat aggressive) baseline expectation for underwritten mortality at a major life insurer. To get a $12,500 level pay premium on a product with that chassis, you’d need a crediting rate of 6.72% – a number that was unimaginable just 12 months ago when Moody’s Baa bond yields were hovering just above 3%. I should also note that the imputed crediting rate isn’t necessarily the same thing as the yield required by the life insurer to support the cash flows in the product. It’s simply the crediting rate required to keep this particular policy in force to Age 121. But it’s a reasonable proxy.

The fact that some life insurers held the line on Guaranteed UL pricing even as interest rates fell in the wake of the Financial Crisis and stayed low for nearly a decade represented, in my view, nothing short of a massive all-in bet on interest rates. But those sorts of bets can only go on for so long. Even some of the most committed players in the space couldn’t handle the heat of 2020. Lincoln repriced from a market-leading rate of $12,138 in this cell as of July 2019 to $14,187 in November of 2019 as rates fell, then to $17,069 by May of 2020 and ultimately pulled the plug on the product later that year. So did Prudential. So did Symetra. So did Principal. It took 10 years for the US insurers to follow what their Canadian and European counterparts did in 2010.

It is amazing, really, that any company would continue to offer Guaranteed UL at historically competitive rates after April of 2020. But they did. Take a look at the pricing for Guaranteed UL products in market today in the table below. I’ve also included the imputed crediting rates for this cell using cost of insurance charges equal to 85% of Preferred VBT.

The reality is that competitive Guaranteed UL prices already reflected a rising interest rate environment before it actually happened. Since 1919, the Moody’s Baa composite has had an average yield of 6.85%, as measured on a monthly basis. Guaranteed UL is a long-term liability. Companies pricing competitive products used long-term assumptions, particularly the assumption that investment yields would revert to the long-term average. The closer the Moody’s Baa yield gets to the long-term average, the closer these life insurers get to being in the black on their Guaranteed UL blocks.

But we’re not there yet, at least not based on this analysis. Moody’s Baa yields are currently sitting at 5.89%, the highest they’ve been since 2011 but nearly 100bps off of the long-term average. If a life insurer came into market today with a fair-market priced product based purely on today’s Baa yields, then they’d be priced at 10% above the cheapest product. Using the current Moody’s Aaa yield of 4.77%, they’d be 28% higher. And using the current 3.82% 10-year Treasury rate, the gold standard of fair value metrics, the product would be priced nearly 50% higher than the cheapest offering.

The reality is that if a life insurer wants to compete in the Guaranteed UL market, the assumption of mean reversion in interest rates is still a requirement. As a result, I don’t think that we’re going to see a new price war in Guaranteed UL – but I do think we’re going to see some action. Here are some trends that I think we may start to see over the next year, assuming that rates stay where they are.

Reprices for Short and Single Pays

Life insurers using mean reversion pricing don’t price their products under the assumption that rates revert to the mean immediately. Instead, they tend to assume gradual rate increases over the next decade or more. This is a problem for single pay designs because the pricing model essentially recognizes that big premiums in early years can’t be reinvested at higher rates until the initial assets roll off. That’s why single and short pay pricing, if the option is even available, was much more affected by low interest rates than level pay pricing.

My anticipation is that some companies will make their single and short pay pricing much more competitive as the rates at the front end of their pricing model start to reflect today’s investment yields. Take a look at two hypothetical scenarios, both with the long-run average crediting rate of 6.55%. The first starts at 3% and climbs to whatever number produces the 6.55% average. This is reflective of how earned rates looked 12 months ago. The second starts at 5.9% and grows to whatever produces the 6.55% average, which is reflective of where we are right now.

For companies using mean reversion, the fact that interest rates have increased doesn’t mean they’re going to drop level pay rates across the board, but it does mean that they may be able to make significant pricing moves for short pay designs. And if that happens, it could be open season on mature Whole Life policies with strong but lagging dividends. Swapping a mature Whole Life for a single pay GUL looks great on paper but, over the long run, chances are good that the Whole Life will meaningfully outperform the GUL, especially if rates continue to increase. Clients should pause to consider that before taking the easy guaranteed death benefit bait.

Fair Value Players Reprice and Reintroduce

Looking at the lineup of current Guaranteed UL sellers, there’s one company that is clearly attempting to price to fair value – MassMutual. Their philosophy, as they’ve explicitly told their field and has been backed up by their pricing moves in Guard UL, is to price to fair market. As a result, I would anticipate that MassMutual will make some significant price reductions in the near future, putting them solidly in the middle of the pack for Guaranteed UL pricing rather than far out on the tail.

But what will be more interesting to watch are the life insurers that decide to get back into Guaranteed UL now that rates have come up. They probably won’t be hyper competitive, but they’ll be able to grab some flows. That’s particularly true for companies that have affiliated distribution – think New York Life, Columbus Life and perhaps even Equitable. I’m fairly confident that Guaranteed UL inventory is going to expand, even if these new entrants don’t rise to the top of the pricing benchmark.

Stock Companies Stay Out

What will be equally as interesting, though, are the life insurers who continue to stay out even as rates increase – particularly those who have massive legacy Guaranteed UL blocks. Most of those life insurers have squirreled away their GUL exposure through labyrinthian captive reinsurance deals. The net effect of those deals is to front-load the profits of those blocks by releasing “redundant” reserves and instead using “economic” reserves in the captives. It stands to reason that those “economic” reserves often hinge on some level of mean reversion assumptions, otherwise the much-reviled “redundant” statutory reserves wouldn’t be redundant.

Blocks that have been reinsured don’t necessarily produce profits now that rates are increasing because those increases were likely already priced into the deal. Rising rates simply stave the damage. Consider the fact that Prudential just took a massive write down on its GUL block at exactly the moment when, if you were looking purely at interest rates, you would have expected them to take a dividend. Lincoln’s stock dropped like a stone on the same day under the assumption that Lincoln would also take a similar adjustment. Brighthouse and Manulife, parent of John Hancock, also came under some questioning from analysts about the potential for write downs.

For these insurers (and a few others), getting back into Guaranteed UL in any meaningful way is probably a no-go. There’s too much baggage. There’s too much exposure. There’s too much leverage already. It’s hard to imagine any of these companies plowing back into Guaranteed UL after spending a decade performing financial wizardry to rid themselves of the liabilities and getting grilled by investors at every step along the way.

Those blocks probably need to start producing reliable, non-engineered distributable earnings before these companies start writing new Guaranteed UL business in any substantial volume. And I would argue that we’re still a couple hundred basis points in invested yields from that happening, particularly when you consider how long Guaranteed UL liabilities are and how flat the yield curve is.

Guaranteed VUL Remains the Product of Choice

However, the story for Guaranteed VUL is more positive. Earned rates have less of a direct impact on Guaranteed VUL because the underlying asset class is equities, not fixed income. Rising rates have a double benefit for Guaranteed VUL in that they simultaneously raise the expected equity return (assuming a stable long-term equity risk premium) and discount potential losses in tail scenarios. I would expect the companies in the Guaranteed VUL space to retrench with lower prices.

However, I still think it’s an open question as to whether more companies will get into the Guaranteed VUL space. Writing GVUL means taking on no small bit of equity tail risk that has proven to be near-fatal to some life insurers in Variable Annuity with Living Benefit products. Guaranteed UL is tame compared to Guaranteed VUL. And for that reason, I maintain that I don’t think that we’ll see more than a couple of serious entrants in the Guaranteed VUL space. The ones that are in are the ones who, presumably, have decided they want the risk and now the question is just pricing. The ones who are out don’t want the risk at a price that will produce any sales, so why bother?

The Term Pricing Skirmish Continues

Term pricing, in my view, is more art than science. The basic pricing ingredients are a mish-mash – mortality, interest rates, carrier cost of capital, expense allocations, commissions, post-level term profits, lapses, modal factor pricing, model office composition, you name it. All of these things are blended into the stew of Term pricing. Companies who want to be competitive in the Term space are like the cook who dips his finger in the stew, takes a taste and decides to dump in a bit more of this and a bit more of that to get it to where he wants it to be. Following the recipe is secondary to getting the taste exactly right.

That’s why the Term market is won or lost on very thin margins. The current difference between cheapest and second cheapest in 10 Year Term product for a $1M policy on a 45 year old Preferred male 10 cents. You can’t tell me that the reason is because the companies priced their product in a vacuum and dumped them into the market and just happened to be 10 cents apart. No way. With Term, the whole goal is to be #1 – profits, if there are even any to be had, are of secondary concern for firms that want to be competitive. If getting to #1 means lower prices to 10 cents below the current cheapest product, then so be it. Carriers do it all the time.

Over the past few months, there’s been a flurry of activity at the top of the Term market. The most competitively priced companies – AIG, Trans, Symetra, Lincoln and Protective – have all repriced and traded paint. One way to interpret this activity is that rising rates have improved the economics of Term. I don’t think so. I think that this was just standard jockeying in the Term market that has continued unabated for as long as anyone can remember. The evidence for my view is that the rest of the market has largely maintained prices and prices in the market haven’t compressed, which is what you’d expect to see if earned rates were really a big piece of the Term pricing puzzle.

That said, I think we will see a few surprises. Because Term pricing is so funky, there are probably some companies that are more affected by rates than others, particularly on long-duration products like 20 and 30 year Term. If there’s going to be action, that’s where I think it’s probably going to be.

*This assumption is key to the analysis. At 100% Preferred VBT, the implied rates for the most competitive products go up above 7%. At 70% of Preferred VBT, the implied rates drop to around 5.9%. Looking at COI slopes in Universal Life products, I’ve generally seen anywhere from 70-120% of VBT, so I went with 85%. The thing about Guaranteed UL is that the products are pretty uniform. If a company thinks the imputed rates in this article look to low, then they probably have more conservative lapse, mortality and expense assumptions. If a company thinks the rates look too high, then they’re probably pushing the limit on mortality, lapses or expenses. This article simply reflects what I think looks like a fairly down-the-middle view.