There is a new presence in the financial services world, and that presence is the Registered Investment Advisory firm, or RIA.  A simple description of the RIA is that an RIA firm houses investment professionals who provide unbiased financial advice and guidance to individual investors, based upon the investor’s risk profile, age, level of sophistication, and overall goals.  An RIA considers many different types of investment possibilities for their clients, including stocks, bonds, mutual funds, real estate, commodities, and yes, investment-oriented insurance products.  In some cases, representatives of RIA firms, often referred to as Investment Advisor Representatives (or IARs), are given discretion to direct and execute financial transactions on behalf of their clients.

An RIA firm houses investment professionals who provide unbiased financial advice and guidance to individual investors.

RIAs (and their IARs) can be paid in a variety of ways, including via sales commissions, partial sales commission and partial fees, and fee-only structures, where compensation is not related to the sale of a specific product.  Instead, under a fee-only arrangement, advisors are compensated for their overall expertise and investment knowledge, and not on a product-centric basis.  The failed attempt by the Department of Labor to enact a Fiduciary Rule triggered significant interest in the fee-only RIA space.  Many advisors who previously operated in a commissioned or-quasi-commissioned environment have moved to fee-only RIA firms.

The heightened interest in fee-only RIAs has garnered the attention of the life insurance industry, also. Such RIAs represent a potentially large source of additional business to life carriers.  At the same time, developing a RIA strategy may be more of a defensive tactic than an offensive tactic, as some insurers are concerned about the loss of inforce and new business as a result of rapid expansion into RIAs by competitors.  And then there is the “latest thing” factor.  Independent, unbiased investment advice is a popular concept today – insurers want to participate in this new, emerging opportunity.

However, the fee-only RIA space must be considered from a realistic perspective.  First, many fee-only advisors dislike annuity products and are skeptical of their true value.  Some have been vocal opponents.  Others believe they can achieve the same end result as annuity products using other tools with lower costs and more liquidity.  Fortunately, there are still others that have experience with annuities, have open minds, or are willing to have the benefits of including annuities in their clients’ portfolios shown to them.  Second, insurers must meet fee-only advisors where they live, rather than the other way around.  This means that insurers must create the technology links to advisors’ platforms and create the kind of connectivity that allows an advisor to seamlessly incorporate annuities into the advisors’ existing tool box.  This is not a short or inexpensive effort.  Third, while competitive products are important to RIAs, they are presently not the most important competitive lever to pull.  Products must demonstrably fit a true need or provide excess returns or safety advantages.  Over time, I expect the discernment around products to increase, but today, key annuity offerings include variable annuities, hybrid VAs, Fixed Indexed Annuities, and some SPIAs.  Life and health insurance products, even simple term insurance, are a future consideration for RIAs.

It would be easy to think of the RIA space as just another potentially attractive distribution channel. Unfortunately, I believe that would be short-sighted.  The level of sophistication, capability, support, and competition in the fee-only RIA space is increasing, and will only grow in the future.  The centers of influence leveraged by insurers to accelerate progress in the RIA space do differ from those in traditional insurance initiatives.  For these reasons, an insurer pursuing a RIA strategy should think of it as a brand new business line, not simply a new distribution outlet.

Let me begin by admitting that I am primarily a product development actuary, not a reserve actuary.  That fact alone may convince some readers that I am biased in my thinking, but I’d like to think that I can see multiple sides of this issue.

What is the issue? – Principles-Based Reserves, or PBR. 

Recent regulatory and legislative developments have now anchored an effective date of January 1, 2017 as the date when the clock starts ticking for the transition to PBR.  By January 1, 2020, all new life products must be reserved for using PBR techniques.  In the interim, insurers can migrate to PBR on a policy form by policy form basis.  Is this a good development or a bad development?

You will likely get as many answers to that question as there are noses on faces.  Here’s mine – the perception that PBR was needed developed fifteen years or more ago as new product designs and features emerged which were not explicitly anticipated in formulaic statutory reserve rules.  Insurers developed varying approaches to this conundrum, some using more, some using less aggressive approaches to fill the reserve void.  This was clearly a reality that needed to be addressed.  Well-meaning actuaries and regulators set about to create a more flexible, more prudent reserve approach that would “right-size” reserves.  The emergence of powerful technology tools would support the increasing sophistication needed in calculations. 

So, where did we end up?  Well, let us first acknowledge that we haven’t totally ended up anywhere, because major parts of the VM-20 mechanics for PBR are still in flux, even as we stare the effective date in the face.  Further, the definition of tax reserves under this regime is still undefined.  But the framework is there, and to put it mildly, the framework is unwieldy.

Without diving into the detailed mechanics of PBR, insurers will need to consider three defined layers of possible reserve impact, with rigorous rules around the development of assumptions for all key variables.  Assumptions should be based upon credible experience with an allowance for conservatism, with the degree of conservatism increased as the amount of actual historical experience declines.  Further, these assumptions must be re-visited regularly, to ensure that reserves are adequate “on the fly”.  For reinsured business, the reinsurer is responsible for its own PBR methodology, so the concept of mirror reserving is now out the window.  In some cases, insurers will be expected to perform stochastic on stochastic analysis, challenging the speed and sophistication of internal financial models.  And this entire protocol will be subject to audit by state auditors, outside auditors, and tax auditors – a monumental task, indeed.  Valuation Actuary reports could end up being thousands of pages long.

What will the arrival of PBR mean for new life insurance product development?  Let’s answer that question by first conceding that the deployment of people resources within an insurer to assist in PBR implementation will likely drain some resources away from product development, slowing the pace of new product introductions, at least for a while.

Some other likely implications:

• Except for term life insurance, the impact of PBR on reserves will likely be to maintain or raise them.  Accordingly, term life prices are likely to fall, but prices of most other products will probably rise, especially in this low interest rate climate.
• Insurers will hesitate before developing innovative new designs, especially if the lack of credible historical experience on such a design requires padding reserves with substantial conservatism.
• The greater likelihood of changes to inforce reserves on policies due to environmental changes and emerging experience will make it more common for insurers to change non-guaranteed elements on inforce business.  This could be both favorable and unfavorable to consumers.

A higher interest rate environment would generally help mitigate the impact of life PBR reserves, but as of now, the implications for consumers, agents, and carriers are less than favorable – fewer products, more expensive products, and less stable inforce policy parameters.

As the saying goes, “Be careful what you wish for”.

There has been a lot of attention on Actuarial Guideline 49 (AG 49), adopted in 2015 to guide the sales and in-force illustrations used in presentations of indexed universal life (IUL) contracts. AG 49 introduces many new concepts, and life insurers are still adapting to its requirements. Now the dust has started to settle on some of its provisions and the way carriers will respond. This article reviews the guideline, how companies are taking action, and possible implications for the industry. 

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Individual Term Life insurance has been a staple of the life insurance business since the early 1980’s.  Improvements in mortality and intense competition have driven down term life premiums.  Sales of term life have been stable over the past five years, consistently representing about 20% of individual life insurance sales by premium.  Still, due to the amount of conservatism built into statutory reserves (primarily due to the mortality levels reflected in the 2001 CSO Mortality Table), insurers have been motivated to use reserve financing arrangements and third party reinsurance as means to maintain term price competitiveness.

There are many changes occurring in the life insurance industry and in the external environment which will impact term life products in the future.  Some of the more important drivers are as follows:

1.     2017 CSO Mortality Table: 

It is probable that sometime in 2016, the 2017 CSO will become available as the new valuation mortality table for individual life business. Insurers will be able to adopt the new table as early as January 1, 2017 (in all likelihood), but must be fully transitioned to the 2017 CSO Table no later than January 1, 2020 (again, given current directions).  It is generally believed that reflection of the 2017 CSO Table for reserves (all else equal) will lower term life premiums, particularly for the longer level term periods and older issue ages.

2.     Principles-Based Reserves (PBRs): 

In all likelihood, regulators will adopt PBR as the future of statutory reserve determination, starting on January 1, 2017.  This approach replaces formula-driven reserves with model-driven reserves.  Insurers can choose to defer implementation of PBR on a policy form-by- policy form basis, but most carriers and all products for those carriers must reflect PBR reserves by January 1, 2020, in all likelihood.  The impact on term prices will depend heavily on whether and to what extent an insurer has been using reserve financing techniques to mitigate conservative term reserves.  Everything else equal, adoption of PBR with reflection of the 2017 CSO Mortality Table will likely result in mild premium increases for insurers who have structured reserve financing arrangements, and premium decreases for carriers who have not structured reserve financing arrangements, but these generalizations may not reflect variances by level term period and risk class.  Longer level term periods are likely to benefit less under PBR with regard to lowering prices than shorter level term periods.  Questions concerning the definition of tax reserves in these transitions to PBR and the 2017 CSO are intensifying with term insurers.

3.     Term Periods Offered: 

The future of term life products will remain in 10, 15, and 20-year level products.  There is little technical (reserve) justification for offering high ART premiums after the Level Premium Period.  However, even with anti-selective lapses which occur after the Level Premium Period (LPP), many companies earn a high percentage of their term product profits in the two to three years after the LPP.  In the future, look for the size of the jumps in premiums from LPP premiums to ART premiums to decrease, moderating the amount of mortality anti-selection.

4.     Commissions: 

The recent norm in term life commissions has been characterized by highly heaped, front-ended compensation.  This is not an optimal structure for insurers, as it places nearly all of the persistency risk on the insurer and leads to an environment of mortality anti-selection.  Although the heaped structure enables term sales to reward the agent for his/her efforts, the longer-term prospects for commissions in general (term and non-term) will be toward more levelization.  This can lead to better economics for the insurer, and better prices for the consumer.

5.     Accelerated Underwriting: 

Writers of life insurance are pushing forward with approaches to speed up underwriting, hopefully without deterioration in mortality.  Special care must be taken with Term Life, however, since term products face more anti-selection risk and have experienced poorer mortality historically than permanent products.  Of specific concern for Term Life is the rigor of financial underwriting.

6.     Other Elements: 

Term products have started to “join the party” with respect to accelerated death benefits, and will continue to add in greater numbers of chronic and critical illness accelerated benefits.  Finally, look for the 2017 CSO Table to generate some spark in development of Return of Premium Term, but the product will still only fit in effectively at 20 and 25-year LPPs.

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Term Life will be one of the first product types to undergo a critical carrier review of PBR/2017 CSO implications.  Expect quick migration to the 2017 CSO, but don’t look for large term premium increases even in a post-PBR world.

Welcome to 2016 – a new year always brings with it anticipation and anxiety – as well as new beginnings.  In that spirit, we are happy to unveil our new website and company logo for Pfeifer Advisory LLC. 

We hope that you’ll agree that the new look is bold and crisp.  A big thank you to Dave Gillaspie of Impact Productions for his work in designing the new look for us.  In addition, the website will become a more substantial source of unique industry information and insights in the coming months – so please stay tuned and come back often to visit the site.  One thing has not changed, however, and that is our commitment to our clients to deliver the most insightful, strategic, and unvarnished consulting services regarding life insurance and annuity products and markets.

As we turn the page into 2016, here are ten significant drivers that will impact the direction of the life insurance and annuity markets in the coming year:

1. Interest Rates Increase:

In December, the Federal Reserve raised its benchmark Federal Funds Rate by 25 basis points, the first increase in this rate in nearly a decade.  Some see this as a first sign of a future pattern of steadily rising interest rates, while others see it only as a one-off move that will be subject to choppy economic conditions.  The life insurance industry as a whole would welcome steadily rising interest rates all along the yield curve, not just at the short-end.  Such rate increases would provide relief to inforce product profitability as well as to new business competitiveness.  A better barometer than the Federal Funds Rate for the life insurance industry is the 10-Year Treasury Rate, which has fluctuated in a fairly narrow range from 1.68% to 3.01% over the past two years, and which hasn’t risen noticeably in tandem with the Fed’s recent twenty-five basis point increase. 

2. Department of Labor Fiduciary Rule:

No subject has grabbed more industry attention than the possibility of the enactment of new Labor Department rules concerning the expansion of fiduciary responsibilities for IRA rollovers on qualified retirement business.  This expansion would particularly impact variable annuities and mutual funds.  The life insurance and mutual fund industries have fiercely fought the direction targeted by the DOL in its proposed rule.  Thousands of comment letters have been generated, and public hearings were held in August of 2015 to voice both support and opposition.  A final DOL rule is expected in early 2016, and a number of industry strategies have tried to delay or scuttle the proposal.  The primary industry concerns are the cost of compliance, the ambiguity of certain definitions (such as “advice”) and the associated risk to reps, elimination of heaped sales compensation and bonuses, and the forfeiture of the middle market to robo-advisers and other fee-based distribution.

3. Equity Markets:

Since the economic debacle of 2008, the U.S. equity markets have been on a solid run.  That run came to an end in 2015, with both the Dow and the S&P 500 experiencing declines (the NASDAQ Composite managed a modest gain for the year.)  The most notable characteristic of the equity markets in 2015 was its nerve-wracking volatility.  Out of 252 trading days in 2015, the DJIA rose or fell by triple digits in 124 of those days (49%).  Such volatility dissuades many buyers of full equity exposure products, like variable annuities, variable life insurance, and equity mutual funds.  On the other hand, such activity may encourage buyers to consider equity-based products with guaranteed components like indexed products and variable products with guaranteed minimum benefits.  Many stock market experts are predicting a 5 to 10% gain in the major equity indexes in 2016, but with continued choppiness, as the European and Asian economies struggle. 

4. Principles-Based Reserves (PBR):

After more than a decade of effort on the part of insurance actuaries and regulators, it appears that Principles-Based Reserves (PBR) for life insurance contracts is nearing reality, as the last few state jurisdictions adopt the necessary SVL legislation.  In all likelihood, PBR will become effective on January 1, 2017, and insurers will have a three-year transition period after that date to migrate to PBR for new sales.  So, why are we including PBR as a major driver in 2016?  The reason is because PBR and the associated Valuation Manual (VM-20) require highly complex sets of calculations and assumption protocols, and quite frankly, all but the largest life insurance companies are ill-prepared today to adopt PBR.  Calendar year 2016 will be needed to understand what is required to satisfy the assumption and calculation provisions, including the staffing levels needed.  As important, life insurers will use 2016 to assess which products benefit from PBR, which do not, and which occasionally benefit.  It is reasonable to expect that term products and secondary guarantee UL will receive the most attention, as reserves for these products significantly exceed any cash value available.

5. 2017 CSO Mortality Table: 

Lost in the shuffle of all of the PBR and DOL rumblings has been the introduction of a new valuation and nonforfeiture mortality table, the 2017 CSO.  The new table will supersede the 2001 CSO Table, and will likely be available for use as of January 1, 2017. As with PBR/VM20, there is a three-year transition period allowed for adoption of the 2017 CSO.  This table can be adopted by a carrier even before PBR is implemented.  Like the 2001 CSO, the new 2017 CSO accommodates Preferred Risk Tables and Relative Risk versions and has a 25-year select period.  As would be expected, the mortality rates under the 2017 CSO are generally (but not always) lower than the corresponding 2001 CSO rates. 

6. Index Products:

Indexed annuities (FIAs) and Indexed Life (IUL) have been the explosive sales drivers of the annuity and life insurance segments, respectively.  Despite low interest rates, these products have attracted policyholders with the potential for strong returns with limited downside.  In addition, FIAs have benefited from the appeal of the guaranteed income story.  New sales illustration rules adopted by the NAIC in 2015 created more uniformity around IUL sales illustrations, but innovation has already occurred in ways that allow insurers to differentiate themselves.  Low-volatility/hybrid indexes have stood out to energize FIA sales, but have yet to make strong leap to IUL contracts.

7. Variable Products:

The challenging equity markets have made the environment for variable annuity and variable life products difficult over the past five years.  Sales of variable annuities have been stagnant since 2008.  Variable Life sales had a resurgence in 2013 and 2014, but prior to that time, had dropped for many years.  Many insurers have left the variable products business, and only one has entered.  The successes in the variable business almost all relate to generous guaranteed benefits, whether guaranteed income or guaranteed death benefits.  In fairness, the level of reported variable life sales may be understated due to the presence of offshore Private Placement VUL activity. 

8. Underwriting Trends:

The unmistakable trend in life insurance underwriting today is smarter, faster, and less invasive.  Insurers believe that today’s consumer wants to buy life insurance using a process similar to that of purchasing other goods and services.  That means eliminating or reducing APSs, para-medicals, fluid draws, and EKGs in favor of database checks and telephonic interviews.  The buzz word is no longer Simplified Issue, because that term means little anymore.  Instead, Accelerated Underwriting describes the overall category of smarter and faster.

9. Earnings Pressures on Public Insurers:

The low interest rate environment has pressured the earnings of all life insurers, as interest spreads on new and inforce business have shrunken or disappeared.  Yet the pressures have been greater on publicly-traded life insurers since public shareholders tend to have a shorter-term outlook on acceptable returns and because mutual companies are (on average) larger and have greater short-term flexibility in managing asset portfolios.  Profit targets for mutual insurers are consistently lower than profit targets for publicly-traded carriers (by 150 to 200 basis points of after-tax IRR) across all products.  (Privately-held insurers fall between the mutual and the publicly-traded stock carriers in profit hurdles.)  This difference is explained partially by mutuals’ sales of participating/dividend-paying products, but the difference still exists on products where mutuals expect to pay no dividends. 

10. Proprietary Products/Features

The traditional product development model of creating relatively generic products to be distributed by a large collection of diverse distribution outlets is transforming.  Too many companies have realized the disappointment of developing a vanilla, cookie-cutter product without explicit distributor involvement that has resulted in lackluster sales.  The future will include proprietary products and features that are developed in conjunction with successful distribution outlets.  Such arrangements are characterized by the insurer relying heavily on the distributor for product design input in exchange for the distributor’s delivery of sales goals.  Such arrangements have begun to flourish on the indexed annuity front – over 30% of Q3 YTD sales of indexed annuities were associated with proprietary product packages, and more are teed up for 2016.

The remarkable growth in Keurig one-serving coffee brewers and the companion pods is a business school case study in market dynamics. The coffee pods brewed by these machines do not taste better (according to most people) than the old-fashioned "grind-the beans, heat the water, and shower the beans" method used for many years. In fact, many people feel that pod-based coffee or tea tastes worse than traditional brew.

Further, using typical prices for a bag of fresh coffee beans and coffee pods, the price per cup of coffee is 2.5 times greater to enjoy pod beverages versus traditional brewed beverages. Why are people willing to pay 2.5 times the price? One word – convenience. Less clean up, and a little faster result. Not that brewing traditional beverages is that difficult or time-consuming, but for the benefit of marginal convenience, consumers are willing to pay $150 - $300 for the machine and an ongoing price that is 2.5 times higher.

The life insurance industry is starting to embrace convenience, but the truth is, we have not yet come close to attaining it. To most consumers, purchasing life insurance is still a grueling, uncomfortable, and maybe even an embarrassing process. True, simplified and guaranteed issue forms of life insurance are being sold in greater numbers, but have not adequately penetrated the limited attention span, "I want to click and be done" population in the U.S. today. The "process" now trumps "price" and "product", and will likely continue to do so for some time.

The message in all this? For the middle market, focus on the process. As long as the process becomes as easy as dropping in a coffee pod, customers will place high value on it and happily pay up. 

The strong sales run by Guaranteed No-Lapse Universal Life (GUL products) over the past ten years or so (which crashed in the past six months) can be heavily linked to lifetime death benefit guarantees. The sales mantra was simple – "if you pay this premium, you will have guaranteed death protection for the rest of your life, no matter what" (barring policy loans and withdrawals, of course). But revisions to GUL reserving (AG 38) and low interest rates have made highly-competitive lifetime guaranteed premiums difficult to maintain. The result? Some insurers have left the GUL market because they believe that agents and policyholders will not accept competitive GUL premiums that only guarantee death benefit coverage to age 100 or 95 rather than to age 121.

This could very well be an instance where actuarial theory and agent training and pre-conceptions differ from real consumer attitudes. The average consumer does not expect to live to age 100 (or even age 95 in most cases). Not even one-tenth of 1% of the population lives to age 100, and although that percentage is growing, the typical buyer sees survival beyond age 90 as a "bonus" and would welcome the purchase of a reasonably priced GUL that guarantees coverage to 95. The fact that reserves (and therefore prices) are considerably higher for a full lifetime guarantee versus an age 90 to 100 guarantee led some insurers and agents to leave or de-emphasize GUL. That may be at odds with real consumer needs and might be an instance of in our industry reacting too abruptly.

Is there a lesson in this?