#370 | Securian’s Great Delinking

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Yesterday, Securian dropped a bombshell announcement that, I think, will rank as one of the more surprising and shocking moves in the history of Indexed UL – a history that is inextricably intertwined with Securian itself. Securian has long been a major player and bellwether for the Indexed UL space, entering the market with Eclipse IUL in 2006 and immediately rocketing to a top position in the space thanks to a 17% S&P 500 point-to-point Cap and 9.5% default illustrated rate. Since then, the Cap on Eclipse, which was offered for new sales as recently as a couple of years ago, has fallen in stair-step progression all the way down to 8%. The cruel irony of Eclipse is that the currently declared Cap is lower than the default illustrated rate for policies issued until 2010. No other Indexed UL product has fallen so far.

Why? There are some unique elements at play with Eclipse IUL. In 2006, Securian was a small company called Minnesota Life. The 17% Cap was probably backed by a relatively new investment portfolio that was earning stout yields. The IUL Benchmark Index starts in early 2007 and you can see that the fair market cap for a company with a new money portfolio blended 70% Aaa bonds and 30% Baa bonds would have been nearly 14%. That’s a conservative new money portfolio in that the allocation implies an investment spread. Minnesota Life, however, was explicit at the time about the fact that they were pricing Eclipse IUL without an investment spread. If so, then a 17% cap in late 2006 and early 2007 isn’t out of the realm of reason*.

The strategy worked well for almost a decade. Securian sold the daylights out of Eclipse IUL as the product seemed to be able to magically maintain Cap rates higher than most of its closest competitors. I distinctly remember one particular senior actuary from Securian – who is still there – insinuating during the AG 49 debates in 2014 that Securian held a sustainable Cap advantage over its peers. He even went so far as to condescendingly scoff at the idea that Securian would ever be in a situation where the Cap on Eclipse would fall below 10%. “Unimaginable,” I think, was the term. And yet, here we are.

Securian’s temporary advantage ultimately proved to be the source of its longer-term challenges. The relatively new portfolio grew swiftly through a period of time when interest rates were high. Option budgets in the IUL Benchmark Index are reliably 5% or higher all the way up through 2011, when Securian was regularly in the top-3 sellers of Indexed UL. After that, option budgets began to slowly decline with market interest rates, but at the same time option prices were hitting historic lows. As a result, companies could maintain high Caps and high illustrated rates even though their portfolio investment yields were deteriorating.

Cheap options in the mid-2010s temporarily papered over the fundamental yield problem but simultaneously laid the groundwork for deeper and more enduring challenges. Securian maintained a 13% cap all the way until the middle of 2016, and therefore continue to attract huge amounts of new premium flow. But all of that money had to be reinvested for the long-term at low rates. Every dollar that came in essentially locked Securian, and many other companies, into low portfolio yields for the long-term and at the same time required more and more future premium in higher rate environments to reverse the situation.

Of course, this isn’t a phenomenon that was limited to Securian. Every company that was relatively new to the market in the early 2010s – arguably with the exception of Penn Mutual** – has experienced the same thing. But what has long separated Securian from almost all other insurers is that the company has maintained so-called “linked” rates, meaning that the declared Cap for newly issued contracts is the same as the declared Cap available for in-force contracts. The argument from Securian and other companies that use linked rates is that because new premium is the same whether it’s on a new contract or an in-force policy, it makes sense and is consumer friendly to declare identical rates for otherwise identical products.

But that is only true if the life insurer is consistent in its application of universal portfolio yields, which is what the major mutual companies do with their dividends for Whole Life. As interest rates fall, existing policyholder yields are diluted by new policyholder yields. As interest rates rise, existing policyholders drag on the returns available for new policyholders. Over time, it all works out. But if a company switches from linked to unlinked rates, then the methodology is no longer fair. If a company is linked, then it needs to be linked for life.

That’s why the recent Securian announcement is such a bombshell. After sticking to its guns since 2006, Securian is switching from linked to unlinked rates in its Indexed UL portfolio. Here’s what the bulletin had to say about the reasoning:

To enhance the competitiveness of our IUL products and reflect current industry trends, Securian Financial is changing the way we manage our IUL portfolio starting this September. Our new IUL Portfolio Management will better align the indexed account parameters and fixed account interest rates we are crediting with the investments that were made to support each block of business. Additionally, this will allow us to price products in a way that better reflects the current economic environment – an approach similarly used by most other insurance companies today…We will have distinct indexed account parameters and fixed account interest rates by product.

What Securian is saying, effectively, is that linked rates no longer allow for competitive new business products. This is a stark change from the past 10 years of falling interest rates, when linked rates actually made for more competitive new business Indexed UL rates because portfolio yields were higher than new money yields. Linked rates threw gas on the fire. But now that interest rates have shot up, the gas has turned to water. Linked rates meant that Securian was stuck offering rates based on an old portfolio invested in lower yielding assets. Unlinking the rates allows Securian to leverage today’s higher yields into better rates for new business.

Securian is absolutely right in saying that this change will “enhance the competitiveness of our IUL products,” but they should have clarified by saying “enhance the competitiveness of our new business IUL products at the expense of our in-force IUL products.” And they are also absolutely right in saying that the change “reflect[s] current industry trends” and is “an approach similarly used by most other insurance companies today.” Other companies have shown that they have exactly zero qualms about using portfolio yields to subsidize new business as rates fall and then walling those policyholders off from receiving the benefits of new sales in a rising rate environment. The fact that Securian held out for as long as they did and had to suffer a precipitous sales decline before they followed the pack is a credit to them. It’s hard to blame them for making this decision, that, I’m sure, caused a lot of head-shaking and hand-wringing in Saint Paul.

Now, to the really interesting part – the rates. Because virtually every other company has been delinked for quite a while, this is the first time that we’re seeing a life insurer split its block of business up ex post facto. Here’s how it shook out for Securian’s flagship accumulation IUL products:

Indexed UL BlockEstimated Block SizePrevious SPX CapCurrent SPX Cap
Eclipse + Omega Builder + Orion – 2006-2019$9B8.0%7.0%
Eclipse Accumulator + BGA – 2020-2023 (Aug)$1B8.0%8.0%
Eclipse Accumulator + BGA – 2023 (Sep)$08.0%10.0%

It is not hard to see what is going on. If you pull Securian’s statutory filing for Minnesota Life, the statutory net investment yield for the Indexed UL block is around 4.3%. The portfolio for Eclipse IUL is huge and heavily weighted towards older, lower yielding assets. The current market price for a 7% cap is about 4.2%. Apply that to the $9 billion of Eclipse IUL and that leaves Securian with something closer to a 4.7% yield required for the $1B Eclipse Accumulator block to buy the current 8% Cap.

Current new money rates, however, are higher – much higher. I’ve seen plenty of life insurer NIER reports recently and most insurers are in the 6.25% to 7.25% range, depending on their asset mix. Securian has always been on the conservative side so even if we assume 6%, they can afford a much higher Cap using a new portfolio. Right now, a 10% Cap costs about 5.6%. My sense is that Securian is being conservative with the new Cap. If interest rates fall, they don’t want to be stuck in a situation where they have to drop the Cap quickly because the new portfolio has nothing to fall back on. Unlike the Securian rate setting philosophy of the early 2010s, sustainability seems to be the goal, even at the expense of out-of-the-box competitiveness.

Securian is also not employing the tricks used by other life insurers to juice new business illustrated performance using engineered indices, although Eclipse Accumulator IUL has one. Their S&P 500 Cap is a true, offered BIA. They’re not playing any games with rate setting by assuming a return to “normal” option prices – as in, the ultra-cheap option prices from 2014 that are unlikely return any time soon. They don’t put a fixed interest bonus on the S&P Prism index. Securian is playing it straight.

However, the big story for Securian isn’t the new 10% Cap because the companies that are going to pedal to the metal, like Allianz and its new 12.5% Cap supported by high allocations to engineered indices, are going to have a huge advantage on illustrated performance. Instead, the big story is what a 7% Cap means for all of that in-force Eclipse IUL business. And it’s not going to be pretty.

Over the years, and particularly in the mid-2010s, Securian accumulated no small bit of what might be broadly referred to as “leveraged” Indexed UL transactions – premium financing, VRDO, credit union deals and the like. All of these transactions share the same fundamental premise that the life insurance policy will produce some degree of “arbitrage” over the cost of funds. In the case of premium financing, the cost of funds is the loan rate. In the case of VRDO, it’s the all-in cost of floating the short-term notes. In the case of supplemental benefits for credit unions, it’s the long-term AFR rate plus the requirement of a full refund to the credit union before the policy spits income off to the executive.

From what I’ve personally seen, the vendors and agents involved in these types of transactions have been scrambling for the past few years to explain away the problem of Securian’s continual reduction in Caps. I saw a huge in-force premium financing case last week with an Eclipse IUL policy where the vendor simply assumes a long-term loan rate of 2.8% rather than the actual 6.5% being charged as of the most recent loan renewal. Why? Because the vendor claims that, over the long run, the “historical spread” between the policy crediting rate and loan rate is 3%. And since the vendor can’t illustrate increasing rates, they just lowered the loan rate while telling the client that the actual expectation is for the Cap to increase to offset rising loan rates. And, of course, there’s no way the vendor can show the client what’s actually going on because then there would be hell to pay.

The same logic has been deployed on a massive scale in the credit union space through some of the vendors who have sold hundreds of millions of dollars of supplemental retirement plans for credit union executives. Securian was one of a handful companies to take the business and is the dominant carrier for the largest distributor in the credit union space. From what I understand, there are thousands of Securian policies sold in credit unions. For annual reviews, the vendor has begun to show credit unions their current performance relative to their original illustration projected for all years rather than using the current in-force illustration. This leads to some pretty bizarre stuff, such as two executives at the same credit union being shown different long-term illustrated rates for the same Eclipse IUL product with the same Cap simply because the originally issued Caps were different. It makes no sense. But if the alternative is telling credit unions that their benefit plans are now underwater, then it makes perfect sense.

The core concept behind all of these tactics is that, in the long-run, Securian will increase the cap in Eclipse IUL and things will get back to “normal” – which, in their world, means perpetual arbitrage forever with no risk  as the basic selling point for the client. Instead, the Cap is now dropping to 7%, the portfolio has been walled off and a large portion of Eclipse IUL policies are done with their premium payment period (which means lower net flow into the block). As a result, it’s going to likely be quite some time before that 7% Cap increases. Every month that passes with the Cap at 7%, more of these leveraged insurance deals are going to go sour.

What’s the message in all of this? I think it comes back to something that everyone in Indexed UL knows but doesn’t want to acknowledge – illustrations are worthless and the only thing that matters is fundamentals. The difference between one company and another isn’t about as-issued Caps or illustration gimmicks. The difference will come down to how a company invests and manages the block over time. That’s it. Period. End of story. If everyone believed that and stuck to it, Securian wouldn’t have had to make this change to delinked rates. They could have argued that their fundamentals were good and that, over time, their strategy would bear fruit for all policyholders.

But that story gets no credit. The great irony of what Securian has done is that if you roll the clock forward 20 years, after (almost) all of the assets in all 3 portfolios have rolled over, the yields for Eclipse, Eclipse Accumulator and the new portfolio will be identical. The fundamentals are the same. The long-term performance will be the same, on average, as if this had never happened. Nothing really changes. And yet, everything changes because now Securian can be competitive in terms of illustrated performance. That’s not a knock on Securian. That’s a knock on this crazy industry and its unrelenting addiction to illustrated performance.

*The other element at play with Eclipse IUL was that it credited interest to the end-of-year Account Value, whereas virtually all other IUL products then and now credit interest to the mid-point or beginning of year Account Value. Crediting interest to EOY AV essentially reduces the cost to hedge the Cap because the Cap is being applied to a smaller amount, so the notional for the hedge is smaller. As a result, EOY AV crediting is a short-term subsidy for new business that burns off quickly as more premium is paid.

**Penn Mutual is a little bit of a mystery. In many ways, the histories of Securian and Penn Mutual mirror each other in the Indexed UL market, but Penn Mutual has managed to maintain higher in-force Caps than Securian. My hunch is that Penn Mutual has made up the difference on the investment side of the house, where it has allocated to more aggressive Schedule BA assets and reaped higher yields.