#352 | The Walls are Closing In on Term Conversions
Editorial Note – I am increasingly receiving article submissions from readers and other parties. My role has always been as Executive Editor, which ostensibly means that I’m serving as an editor of this publication, not just an author. It’s my job to ensure that the content lives up to the tagline – independent and objective life insurance product intelligence – whether I’m writing it or not. This piece is a prime example of content that I did not write but fits within the ethos of the site and adds value to subscribers. My role was simply as editor. If you’d like to submit content to TLPR, my ask is that it is consistent with the ethos of the site and is at least 1,500 words. My email address is [email protected]
The author of this piece is Steve Cox, FSA, who I have the pleasure of working with every day at Life Innovators. Prior to joining Life Innovators as Head of Life and Combination Products last year, Steve was the Vice President of Product Development at OneAmerica.
Although the Term market seems to be oriented almost entirely around price, arguably the most valuable part of a Term policy is actually the conversion privilege – and these privileges are under attack. Why? A recent SOA study gives us a window of insight. Conversion mortality is terrible, but it’s particularly terrible for conversions that occur at or beyond the end of the guaranteed level premium period. It is therefore no surprise that many price-competitive Term sellers have moved to restrict conversion privileges to the first few years of the guaranteed premium period, a move that allows them to preserve the talking point of conversion while taking the teeth out of adverse mortality. But the SOA study also shows other problematic fact patterns for conversion mortality – face amounts above $1M, insureds issued at Standard or worse and a few others. Carriers are likely to become more sophisticated in how they calibrate their conversion privileges. That, or they may decide to simply do away with them altogether. Either way, producers need to be more vigilant now than ever to ensure that their clients are getting strong conversion privileges for new policies and appropriately taking advantage of the ones they already have.
No life insurance product is more commoditized than Term. Financial strength considerations aside, price is king. Most advisors and consumers go right to the monthly premium as the deciding factor for which product to buy. For some folks, that’s the right decision. They’ll keep the coverage for as long as they need it and then let the policy lapse. Considerations beyond price are an afterthought.
The fact that many life insurers rely on Post Level Term (PLT) profits and the increasing uncertainty about whether those profits will actually pan out – which was the subject of a recent article – means that Term pricing may undergo massive change. If the chickens are coming home to roost on PLT profits, Term pricing may face a reckoning that would see pricing increase across the board and especially for some of the most competitive players.
But as covered in another previous article, price shouldn’t be the only consideration for Term insurance. Conversion is arguably the most valuable feature of any Term policy. Think about it in basic terms – is it more likely for a policyholder to die or to become less insurable over the 10/20/30 year duration of a typical Term policy? Obviously, it’s more likely that the policyholder becomes less insurable, which means that the ability to convert is more valuable that the actual death benefit for most policyholders. Conversion, in my view, should be right up there next to price as something to consider when buying a Term policy.
The Two Camps of Conversion
Conversion strategy generally falls in two camps for carriers. Traditional, true-blue mutual companies are generally in the first camp. They see conversion as an invaluable growth engine for their whole life business. For these carriers, whole life business sourced from conversions can be 25%+ of their permanent product business. These companies train their agents on the conversion story, have exceptional marketing campaigns to support conversion and provide incentives to both the advisor and policyholder to convert. The conversion story is embedded in their identity. It’s probably not a stretch to say that they sell term primarily to feed conversions.
In the second camp are the companies that are generally the price leaders in the brokerage space. For them, term is blood sport. They know that they have to be price competitive in order to win business. Everything else is secondary. For these companies, broadly speaking, conversion has historically been seen as a necessary element of offering term. They know that agents expect it and that it’s part of the sales pitch to the consumer. Conversion isn’t seen as a positive but, at least until recently, it wasn’t seen as a negative either.
If you haven’t felt it already, the walls are continuing to close in on your ability to convert. Conversion privileges are becoming scarce and the ones that remain are less compelling than they used to be. Something is going on with conversions. The actuaries have seen something and they’re starting to act.
Conversion Experience Data – Pulling the Covers Back
From the carrier perspective, there has always been the expectation of a “cost” to conversion. The company is providing issue-age based pricing on an individual who was underwritten several years prior, so the difference between newly-underwritten mortality and “point-in-scale” mortality was used to develop a cost of conversion. Pricing practices varied as to whether that “cost” was reflected in the term premium (impacting its premium), or whether it was reflected in the conversion product premium (impacting its premium and/or non-guaranteed elements), but by and large, the cost was expected to be relatively benign.
What has happened in the industry over the last ten years has been a massive, and impressive, effort to conduct industry studies on a wide range of topics – conversion experience being one of them. In 2016, the Society of Actuaries worked with several carriers to produce the most complete and thorough conversion study ever conducted by the industry. The results are shocking. Conversion, as it turns out, is about as benign as a sleeping lion.
The SOA Study
For purposes of the SOA study, and for this article, term conversions were broken in to three periods: “Early” conversions (generally in the first half of the level term period), “Mid” conversions (generally from the end of Early until a few years before the end of the level term period), and “Late” conversions (which are those occurring in the last year or two of the level term period).
The first look at the results shows the beginnings of a problem. The chart below shows the mortality of converted policies relative to the cohort of term policies from which they left. The percentages reflect the mortality of the converted cohort over the mortality of the term cohort. This is a measure of the degree to which mortality for conversions is adverse. The gray bars show mortality on a per-policy basis, the yellow bars show mortality on a face amount basis.
Early and Mid conversions aren’t great news – mortality is suffering a 10% to 15% jump for converted policies relative to their former cohort. If you want a quick and easy measure of the “cost” of conversion, this is it. This extra mortality cost, if mapped onto the new permanent policy, represents a cohort of policies with significantly reduced profitability that must be paid for by the fully underwritten policyholders. The adverse mortality is essentially paid for by all of the policyholders who didn’t convert.
However, the problem isn’t Early or Mid conversions. It’s Late conversions, which see a dramatic spike in mortality experience after conversion – 35% to 50% higher mortality. Intuitively, one can see how this makes sense – unhealthy policyholders see the end of their level term period approaching, and know that they have become uninsurable (at least not at an acceptable rating). The prudent advisor has likely tried to roll the policy in some way, and they’ve seen the underwriting offers. The best (and perhaps only) course of action is to convert and lock in a new level premium in a permanent chassis. Yes, it’s a high premium, but it’s cheaper than the alternatives. And, in some cases, the agent may even be able to thin-fund the new permanent policy to match the reduced life expectancy of the client.
A closer look at this data shows an even more disturbing result for the carrier: the result by amount (yellow bars) is worse than the result by policy count (gray bars). What does that mean? Large policies have worse experience than small policies, compounding the problem from a total financial perspective. Looking at the same mortality results, but now splitting it out by policy size shows the following:
The best mortality results for problematic Late converters are for smaller term policies, under 250k. For those smaller sizes, mortality is elevated at conversion, but it’s arguably bearable and largely consistent across the generation of conversion. However, as size increases, the spike in mortality by generational cohort becomes stark – – policies over $1 M that convert Late have mortality that is nearly 200% of the cohort from which it just left.
It doesn’t take an actuary to know that 200% mortality isn’t going to work out well for the underlying product. It’s unsustainable and unacceptable from a carrier perspective. Further dimensions of the study show that mortality is highest in those first three years after conversion, and then begins a slow reversion back to an acceptable range – but that reversion occurs over the decade following conversion. In short: conversion mortality spikes dramatically after conversion and takes several years to correct itself. And to make matters worse, the larger the policy, the bigger the spike in mortality and the more likely it is that the agent is going to take the time to actually push for a conversion (and a new commission).
Does it Matter if Nobody Converts? – Conversion Rates
Cleary, these mortality results only matter if conversions happen. Take a look at the conversion percentages by policy duration for 10 year Term:
Note that in this industry study, conversion periods were often to the end of the LT period. Some policies in the study had conversion periods to an attained age, regardless of term period. In addition, some companies would allow conversion after the level term period on an exception basis.
Industry conversion rates run in the 1% neighborhood during the level term period (this applies to T15 and T20, but the displayed T10 is the most credible). However, when we hit the end of the LT period and the ensuing year or two after, conversions spike, with the spike exaggerated for the larger policies. Putting this all together: a spike in conversion rates, coupled with a material elevation in the mortality of those Late converters, which is even worse as policy size increases.
The survey doesn’t break out results by company type, but I don’t think it’s a stretch to assume that the conversion experience is different for companies that focus on conversions – the mutuals in the first camp as outlined earlier – and the companies that focus on pricing with conversions thrown in (the second camp). If I had to bet, I’d say that most of the early conversion activity is reflective of the first camp and the later activity is more reflective of the second camp. Policyholders who convert early are probably doing it because they can now “afford” permanent coverage. Policyholders who convert late are doing it because they have to. Hence, the huge difference in mortality results and the rate of conversion.
Digging deeper, we see that the problem worsens when we look at conversion rates by premium class.
Not only do we see conversion happening late in the period, with a spike in mortality, but we continue to get a sense of the underlying issue when we see that non-preferred classes convert at a 50% higher rate than preferred classes. This is, perhaps, a counterintuitive result. Wouldn’t it make more sense for Preferred policyholders to convert and maintain their Preferred rating? It would, but from everything I’ve seen in my career, a truism applies: once Preferred, always Preferred. People who are underwritten at Preferred are more likely to stay at their current rate class than someone who is underwritten at Standard or worse. As a result, conversion rates are higher for Standard than Preferred, despite the fact that the underwriting class being “locked in” is less attractive.
The problem is clear. Mortality for conversions is terrible. Conversions are slanted to large policies, which exaggerates the financial impact. Non-preferred classes have higher conversion rates, hinting that the conversion block is slanted towards less healthy insureds. And these conversions are happening late in the term period, as the last hope for insurability is grabbed onto. It’s a compounding problem on which the industry study shined a light.
Did individual carriers already know this? Some did, undoubtedly. Those carriers with sophisticated systems and data can likely see it in their data – if they know to look. However, a recurring qualifier in the study is the low quality of data, controls, and accuracy that existed (and still exists) at many carriers, which had to be cleaned up over the course of the study. If carriers had to clean up their data for the study, that can only mean that they weren’t paying attention to their own experience. This study shows that the problem cannot be ignored without financial fallout.
The Carriers’ Conundrum
The carriers seem to now be paying attention, as it’s easy to see that something has to be done. Conversion is still an extremely valuable product feature that’s worth saving. However, the evidence of the need for change is overwhelming. Short of eliminating conversion altogether, carriers have a few levers to pull, and there has been, and will continue to be, activity on all of them.
Conversion Period – The conversion period is the number of years where conversion to a permanent product is offered. 20 years ago, it was typical to see the conversion offer extend for the entire level term period – so 10 years for a T10 product, 20 years for T20, and even 30 years for T30. This was typically subject to a maximum conversion age of 65 or 70, but the opportunity for younger term purchasers to convert was generous by today’s standards. Some carriers even offered conversion beyond the LT period, either for an additional period of years, or to an attained age regardless of term period. In the SOA study above, 74% of inforce business has a conversion period at least equal to the level term period – but you can bet that number will be decreasing going forward as carriers retract that standard.
Conversion windows are closing in and for good reason. The primarily driver of adverse mortality in conversions is clear – the longer the conversion window stays open, the worse the mortality will be. Companies can still retain a conversion privilege while taking the bite of out of mortality simply by limiting the number of years that conversions are available. The conversion privilege might be limited to the term period minus some number of years or just the first 5 or 10 years. That way, the insurer can retain some level of a conversion privilege but manages to cut off the most frequent and problematic sort of conversions.
Conversion Extension – To counterbalance reduced conversion windows, conversion extension riders are making a comeback. The rider benefit is straightforward – if a client wants to have the safety net of a longer conversion period to protect against adverse health events, they need to pay for it. That way, the cost of Late conversion adverse mortality can be mapped directly to the feature itself. These riders are a convenient way for carriers to modularize their product, and keep as much cost out of the base plan as possible to stay high on the rate comparison sheet, while still offering the option of a longer conversion period. Based on new product releases and new filings, this is going to become the norm, not the exception.
Conversion Credit – Conversion credits essentially amount to a discount on the first-year permanent product premium to entice a policyholder with some “savings” to convert. From a pricing perspective, it’s not a material impact on the cost of conversion, but it has a nice ring to it for marketing purposes. These credits used to be fairly commonplace, but some companies are now using it as a “rate special” for limited periods of time, rather than a permanent offer. Or, the conversion credit is only offered in the first few years of the term policy, and no conversion credit is available after that. One major term provider offers a conversion credit only for conversions in the first two policy years.
Conversion Product – Perhaps the most under-appreciated aspect of term conversions, to the casual producer, is the availability of products to which a client can convert. This presents yet another chasm between the mutuals and the brokerage providers – the mutuals in the first camp offer the good stuff; the others in the second camp typically do not. As noted at the outset, the mutuals see term with conversion as a growth driver for their permanent products. The ability to convert to street products, particularly Whole Life, is a core part of the value proposition.
On the flip side, it is common in the competitive term space to offer a “conversion-only” permanent product (as covered in this article) for those that opt to convert. These conversion-only products are typically of limited value, in large part because they are priced with the expectation of very poor mortality. There are contracts that allow conversion to “products made available for conversion”, an ambiguous punting of the specifics for what you might have available for your client in 10 or 15 years. There have been dramatic price changes on the conversion products, further deteriorating the value of the new coverage. Conversion product availability is the least-talked-about important feature of a term sale. It shouldn’t be.
Where Conversions (Might) Go From Here
If you read through the list of actions above, you’ll see common threads with the SOA data. Late conversions are a problem, therefore insurers are cutting back on the length of conversion privileges and providing for-fee riders to extend the privilege. Mapping conversion “cost” onto permanent insurance is a problem, therefore life insurers are releasing conversion-only products. But there are a lot of other factors that are conspicuously absent.
It seems like companies are still in the early phases of grappling with conversion. Based on the SOA study, it seems like insurers would do well to limit conversions privileges to only Preferred and Preferred Best risk classes. It seems like they would also do well to apply a face amount cap that can be converted in order to mitigate the damage of adverse mortality on the conversion. I’m sure there are even more granular cuts of the data that would provide more insight, potentially by issue age or sex or any number of other variables. There’s a lot of room for much more sophisticated and targeted approaches to conversion privileges and it’s probably inevitable that life insurers will start to implement them.
That, or they’ll give up on conversion altogether. There seems to be a huge gap between the actual cost of the conversion privilege and the marketplace’s perception of its value, at least for companies in the second camp made up of term price competitors. Companies generally want to offer features that are the other way around – very low actual cost with huge perceived value. Is it really possible that the cheapest Term product in the market won’t get sales because they don’t have a compelling conversion feature? Probably not. As a result, it’s not surprising that some companies have decided to just ditch it altogether. More will likely follow.
What’s a Producer To Do?
As a producer, having an eye towards the future and what adverse health events are possible for your client, the availability of a strong conversion option should be a critical part of your product analysis. Over the course of a client’s level term period, it’s not a stretch to say that they are much more likely to have a deterioration in their health condition (and thus insurability) than they are to actually die and trigger the term death benefit. You should be prepared to have the discussion down the road in the more likely event of deterioration in health. If conversion is in the back of your mind with a term sale, and it should always be there, then paying careful attention to conversion details can save you from a troubling client conversation.
While you may have felt like Luke, Leia, Han, and Chewbacca in the trash compactor with the walls closing on you, they may be closing faster than you thought. Your office may have received notices about changing conversion practices that went unnoticed, so it may be time for you to deploy your own office R2D2 to check all of your carriers’ practices so that you can get through the escape hatch with any client that needs it before it’s too late.