Vol 6 No 3		April 2004

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No Lapse Premium Guarantee (NLPG) Policies - Update

The real issue in assessing the relative risks of buying very aggressively priced NLPGs is whether ADULT SUPERVISION will arrive on the scene in time to push them back from the brink.

The May 2003 issue of this newsletter (Vol. 5, No. 4) discussed a relatively new permanent life insurance concept that we refer to as no lapse premium guarantee (NLPG) policies. These universal life policies have very exaggerated guarantees that make their premiums and death benefits guaranteed. They are static-priced, which is in contrast to all other permanent policies that are market-priced. Static-priced NLPGs are only used for level-to-maturity-death-benefits. Market-priced policies with level death benefits will have premiums that will change, primarily as interest rates change. Therefore, we can't know in advance if a market-priced or a static-priced NLPG will be a better value but we can indicate approximately what interest rates must average in order for a market-priced policy to do better.

The exaggerated guarantees used for the lowest priced NLPGs are worrisome because they may not adequately cover the reserving that is required. If NLPGs fail to meet reserving needs an insurance company would need sufficient profits in its non-NLPG policies to avoid insolvency. We have begun referring to NLPGs as the junk bonds of permanent life insurance to indicate the additional risk involved.

In addition to very low NLPG premiums we see some companies doing very aggressive underwriting (i.e., offering standard ratings when other companies offer sub-standard ratings in order to make the sale). Very low priced NLPGs alone or in combination with aggressive underwriting can put pressure on clients making life insurance purchase decisions because of how low their premiums are compared to alternatives.

A recent case will explain how these issues impact decision making. This is a second-to-die policy situation with the female a preferred risk. This couple has a 24 year joint life expectancy. Company A that has very low NLPG premiums has offered the male client standard. Company B that also has very low NLPG premiums has offered him a sub-standard Table 3. And Company C that only sells market-priced policies has also offered him a sub-standard Table 3. Doing some sophisticated pricing analysis we advised the client that Company C's market-priced policy will need a geometric average interest rate of 8.0% to beat Company A and 7.0% to beat Company B. Because we can't predict future interest rates he decided to diversify his purchase between static- and market-priced policies if we could develop a comfort level for the apparent risks associated with aggressively priced NLPG policies.

Company A has the greatest amount of risk because not only does it have very low guaranteed premiums but its underwriting seems very lax, which will increase its mortality costs relative to companies doing prudent underwriting. Company B's risk is only due to its very aggressive guaranteed premiums because its underwriting appears to be prudent. Company C, that has top financial strength ratings from all but one of the rating services (second ranking with the other), is the equivalent to a AAA bond compared with the NLPG junk bond equivalents, with Company A being the junkiest.

The real issue in assessing the relative risks for my client buying some of his insurance from Company A, that has decidedly better pricing than Company B's NLPG, is whether adult supervision will arrive on the scene in time to push Company A back from the brink of this very aggressive pricing. If we can develop some confidence that this kind of dangerous pricing won't continue than it offers an opportunity for my client because he will get the benefit of very low premiums without as much of the attendant risk I might otherwise assign to it. Last year I published what I believe was the first piece critical of NLPGs and began lobbying for other nationally recognized commentators to also weigh in on this important subject. Help has recently arrived. Joseph Belth's the Insurance Forum devoted its March/April issue to these NLPGs and if anything found them to be more dangerous than I have. Moody's Investors Service put out a Special Comment in January that warns of the hidden credit risks to NLPGs via reinsurance issues. I have noted that the life insurance pricing actuarial profession's concerns have been increasing with more public discussion. And anecdotally I learned that state insurance company auditors are very aware of the potential reserving problem with NLPGs. This enhanced public scrutiny suggests to me that very aggressively priced NLPGs may not persist and as noted this decreases my concerns. My best time estimate for ending the most aggressively priced NLPGs is around five years. However, as a cautionary note it isn't certain that companies wanting to give agents the hottest product won't keep plunging ahead by finding creative ways around possible new regulations.

Because Company A's static-priced NLPG has potential advantages for my client he decided to purchase 30% from Company A and 70% from Company C with market-pricing. Because of the arrival of astute adult comments about NLPGs we believe the risks of Company A are worth the potential benefits.

What Price Neglect

For the past eight years we have annually advised an ILIT containing about $20,000,000 of life insurance. This year we discovered that the ILIT also owns four smaller paid-up participating whole life policies from the same company a $9,000,000 policy in the ILIT is with. These four smaller policies have combined death benefits of $704,000 and cash values of $544,000. The Trustee didn't think it was necessary to review them and had not previously mentioned them to us. These four policies were all purchased during the 1970s. Our evaluation of the pricing showed that the mortality component of the dividend was very high. The mortality for the $9,000,000 policy purchased in 1987 is about 45% of the 1975-80 mortality table but the four policies purchased in the 1970s is 130%. Even though this is a very good company the pricing on their older policies is very poor. This is mostly due to the 1970s policies not have nonsmoker discounts. We are in the process of replacing these policies with maximum wholesale (minimizes the commissions) paid-up participating whole life policies. The immediate advantage to having policies with nonsmoker mortality costs is 10% growing to 30% by life expectancy. The present value advantage to having discovered this pricing problem is about $275,000.

ALL OF YOUR CLIENTS' LIFE INSURANCE NEEDS TO HAVE AN EXPERT FIDUCIARY REVIEW.