UNIVERSAL LIFE PRODUCTS

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UNIVERSAL LIFE PRODUCTS

• K S Gopalakrishnan
• 27 Aug 2009

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history

• Started in the USA in 1970s in response to need
  for an adaptable product
• Buy term and invest the difference
• Sales picked up in mid 1980s
• Sells well when interest rates high

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what is universal life

• Established the principles of unbundling and
  transparency
• NAIC definition universal life is any life
  insurance policy where there is a separate
  identification of mortality and expense charges
  as well as the amount of credited interest on the
  account value
• CIA universal life is the generic name given to
  a plan of insurance where premiums are deposited
  into one or more funds and charges for insurance
  and expenses are deducted from these funds. The
  timing of premium payments may be fixed or
  variable and is not necessarily related to the
  timing of the deduction of insurance and expense
  charges.

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what is universal life

• Account value at end of month t
• Account value at end of month (t-1)
• premiums in month t -
• premium load in month t
• expense charges in month t
• risk charges in month t
• any withdrawals in month t
• guaranteed interest credited return in month t
• any bonus credits in month t
• Surrender value account value surrender charge

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what is universal life

• Policy will remain in force as long as surrender
  value is positive
• Most purchasers do not like front end loads most
  designs therefore recover costs through a
  combination of surrender charges and charges over
  policys life. Allocated portion of premium
  tends to be high (90 to 100) and surrender
  charge runs long e.g. 10 years
• There are three main variations of universal
  life
• - Single Premium
• - Fixed Premium universal life requires that a
  fixed premium be paid for some period of time,
  just like a traditional product
• - Flexible Premium universal life (UVL) allows
  the policyholder to vary or even stop premium
  payments, subject to either a minimum cumulative
  premium being paid or the account value being
  greater than zero.
• Premiums for fixed premium UVL products are
  usually calculated to be sufficient to mature the
  policy (e.g. to accumulate an account value that
  equals the death benefit).
• Expense Charge deducted every month from
  account value variety of methods (fixed amount
  of premium)

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what is universal life

• Death benefit options Death benefit can be in
  various forms including (a) sum assured plus
  account value (b) higher of sum assured and
  account value (c) a of account value (d) sum
  assured plus premiums paid less withdrawals.
• Switching between death benefit options allowed
• Riders allowed, including coverage on lives of
  spouse and children, no lapse guarantee rider
  etc.
• Withdrawals from account value allowed
• Policy loans allowed
• Surrender charge often expressed as of
  premiums.
• No investment fund options and policyholder gets
  an interest rate credited to the account value,
  .. (see later slide)

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Canada Style

• Several investment options can be available.
  Money in policy fund may be allocated to a
  variety of investment accounts based on customer
  choices.
• Sample investment accounts
• Floating Interest Account (fund earns interest
  each day)
• Guaranteed Interest Accounts (GIAs) example GIA
  1 year, GIA - 3 year, GIA 7 year interest
  rate can be set with reference to an external
  benchmark example 95 of Government of India
  bond rate in effect on the day the company sets
  the interest rate for the same term, less 150
  basis points.
• Within a policy, there can be several GIAs. When
  a GIA matures, the company may have the default
  option to put the money in a new GIA for the same
  term.
• On withdrawal of money from a layer of GIA,
  before it matures, the company has the right to
  levy an interest rate penalty if interest rates
  for the same term at the time the policyholder
  makes the withdrawal are greater than the
  interest rate of that layer. The company decides
  the amount of interest rate penalty.
• Accounts based on the performance of indices
  example account value based on performance of
  Nifty 50 subject to management fees of 2.0 per
  annum. The account value is updated every day.
• If a policy has GIAs, deductions and withdrawals
  will be from the layers closest to maturity.

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Commission

• Most UVL products pay a high commission on first
  year premium. In flexible premium UVL products, a
  high commission is paid on first year premium up
  to a target premium. Premiums in excess of target
  premium receive a low commission, as do first
  year top-up premiums and renewal premiums.

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so, how is UVL different from unit linked

• Unlike a unit linked where policyholders choose
  one or more investment funds, in a universal life
  product the insurance company manages a single
  fund having exposure to various asset classes and
  declares interest rates at periodic intervals.
• Such contracts are typically backed by bonds and
  hedging of the investment guarantee risks is
  actively practiced.
• The insurer would manage a consolidated universal
  life fund with sharp Asset Liability Management
  practices.

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so, how is UVL different from unit linked

• Policyholder money is in general fund (not
  segregated funds)
• Account value has a minimum guaranteed interest
  rate (say 3 p.a.)
• The account will also normally pay excess
  interest
• Companys spread is the excess of what it earns
  over what it credits spread not known to
  customers
• Crediting rate can be based on portfolio rate or
  new money rate
• Bonuses may be paid for persistency (e.g. at end
  of year 10, 10 of all credited interest return
  of a of risk charges every five years)
• Credited rate is usually declared every month and
  interest is credited monthly. The rate in first
  year may be guaranteed. The rate may vary by size
  of account value.
• One example
• Interest is credited to the account value. This
  interest is based on the interest rate the
  company declares periodically. Such interest rate
  is declared at least once annually and will be
  never less than the guaranteed rate of 3 p.a..
• UVL aggregate funds run risk in that surrenders
  during times of high interest rates could lead to
  capital losses.

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crediting strategy

• Examples
• UVL portfolio average annualized earned rate for
  the previous quarter, net of investment expenses
  and provision for default, less 1.50, but not
  more than 0.5 different from the competitors
  rate defined as the larger of the rolling
  average 2-year government bond less 0.5 and
  5-year government bond less 0.25.
• Credited interest rate equal to the rate earned
  on five year government bonds minus 0.25
• Credited interest rate equal to 70 of the
  increase in the Nifty 50 stock index

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Surrender value

• Surrender value is
• The account value, minus
• Any interest rate penalties on GIAs, minus
• Amount of policy loan, including interest, minus
• Surrender charge

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Surrender Charge

• To recoup expenses (expressed as of premium)
• Market Risks - UVL products are exposed to market
  risks as market value of the underlying assets
  could be different from the amortized book value
  due to interest rate changes. To reduce this
  danger, UVL products often feature a market value
  adjustment (MVA) that reflects the current market
  value of the assets backing the surrender value.
  This is often accomplished through a formula that
  approximates the effect of interest rate change
  on market values. MVA can lead to surrender
  value being higher or lower than the amortized
  book value.

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misc

• Loan A typical maximum loan will be 75 of
  surrender value
• Lapse when account value minus policy loans
  including interest is equal to or less than zero
• Reinstatement on payment of reinstatement amount
  as set by the company

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india

• Reference to Universal Life in IRDA (Asset,
  Liabilities and Solvency Margin) Regulations.
  Defines Universal Life as those contracts that
  are presented in unbundled form. The contracts
  where policyholders have an option to invest in
  units of insurers segregated fund(s) shall be
  treated as linked business and others shall be
  treated as non-linked business.
• With profits?
• Required solvency margin?
• Valuation?
• Will it sell?
• Benefit illustration investment return rates (6
  and 10)
• Definition of UVL (or what is not allowed in UVL)
• Rules in Unit Linked guidelines (min SA, lock-in,
  lapse) and cap on charges in Unit Linked (no
  surrender charge after 4 years maximum charge
  over policy term)

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india

• Possible interest credit?
• A minimum rate of interest credited must be
  specified in policy document
• Actual interest rates may exceed the guaranteed
  rate at the insurers discretion
• Documented crediting rate strategy to be filed
  with IRDA as part of FU annual review of the
  strategy to be performed and reported in FCR and
  AAAR.

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India Valuation non-linked UVL

• ALSM Regulations specify prospective gross
  premium method BE with MAD reserve floors
• Key points to be noted
• Many elements are common with general method of
  valuation of with profits contracts.
• Expected Credited Rate
• Future competitive pressures may reduce the
  spread available
• Assets and liabilities may become mismatched,
  causing a potential decrease in spread
• Normally, investment spread should not be assumed
  to increase in the future
• A number of interest rate scenarios might be
  needed
• Policyholder behavior may vary under different
  interest rate scenarios eg Premium persistency
  to be modeled for example, low premium
  persistency rates could be expected if interest
  crediting rate is based on portfolio rates and
  new money rates spike upwards. (similarly,
  partial withdrawals and fund switches)

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