A type of insurance with a mixed reputation is making a comeback.
Firms are looking to head off a wave of policy swapping when interest rates rise by reintroducing adjustable-rate policies.
Sold in the 1970s and early 1980s, these policies fell out of favour when interest rates dropped, causing premiums to rise. Now, with interest rates poised to increase, some insurers are betting it’s time for adjustable’s return.
Companies had to raise permanent insurance prices, starting in 2010, to deal with low interest rates and weak investment returns. Some raised capital on the markets, increased reserves or cut shareholder dividends, says John McKay, executive VP and actuary at PPI Advisory. “The industry is strong,” he says, but future success now depends on how companies prepare for a return to higher interest rates.
While it’s uncertain when rates will rise—some economists predict low rates until 2016—the Bank of Canada has little choice but to raise its longstanding 1% rate.
When that happens, companies’ investment returns will rise in tandem, allowing them to lower premiums.
“People will be able to buy new products for cheaper,” says Byren Innes, PwC’s senior strategic advisor, Financial Services Consulting and Deals.
When this happens, advisors will be well-positioned to get clients to sign new policies, and they’ll tell existing customers about the potential savings, he says.
“Most consumers would say, ‘Sounds good to me,’ ” he says. “That’s when the replacement starts to happen; there will be turnover and re-writes.”
Clients will score savings while advisors will gain first-year commissions and bonuses—leaving insurers with the bill, he adds.
People healthy enough to qualify for new insurance will move to less-expensive plans. Those who aren’t healthy will be left in older policies.
And that will throw off the insurer’s predictions for the existing plan’s payout and mortality rates—the plan becomes more expensive for the insurer, says Innes, but the company must honour the policy.
As recent customers abandon existing policies for cheaper ones, companies won’t necessarily recover the cost of signing those clients, he adds.
“The typical cost to put a piece of new business on the books… is somewhere in the neighbourhood of 300% or more of the first-year premium,” he explains.
What this means for firms
When clients abandon policies, companies may also owe them payouts. While firms are obliged to have enough assets to cover these costs, earlier payouts may force them to liquidate some investments sooner than expected, Innes says. Bonds make up a large part of insurers’ portfolios, and they’ll be worth less when interest rates rise.
Their lower value, along with the expense of selling assets, may cause insurers to incur capital losses, he says. How much these factors hurt companies depends on the speed and size of interest rate shifts, he adds.
Some insurers are looking at adjustable life policies to mitigate interest rate risk and protect returns. In 2013, Empire Life and Industrial Alliance launched products promising lower costs when rates go up. The policies set a guaranteed maximum premium.
“Everybody wins in that deal. The insurance company still gets the profits it wanted, and the customer gets a good deal,” says Innes. “This is exactly the time to buy adjustable.”
Problem is, the reputation of adjustable policies was hurt by policies sold decades ago. Back then, interest rates reached double-digits, with the Bank of Canada key rate peaking at 21.24% in 1981. When rates dropped in the ’90s, premiums jumped, leaving advisors with surprised and angry clients.
Bennett March advisor Jason Pereira says these older policies have been a pain for his clients and his practice. He inherited several from a business his firm took over. Policyholders had to choose between increasing premiums or scaling back coverage, he says, and most cut back.
Innes adds people who’d bought older adjustable policies either didn’t understand that falling rates would mean skyrocketing premiums—or they didn’t believe it would happen. And not all advisors may have run the numbers. Now conditions have reversed, which means advisors won’t have to go back to clients with bad news about premiums.
“It should all be positive disclosure this time,” says Innes.
Pereira says consumers will be wary of promises to lower premiums, because “people are used to their insurance costs being set.”
Clients may also be skeptical about a company’s promise to lower rates. It’s important for advisors to outline how contractual requirements will cause premiums to go down, and the factors that will trigger those decreases, says Innes.
Dealing with adjustable policies
Adjustable policies should also offer value to consumers beyond simply addressing the desire to sign up for a new policy when premiums drop, Innes says.
An adjustable policy is unlikely to save clients money if its premiums today are much higher than other policies on the market, he notes. Premiums would have to go down dramatically in future to compensate. In that case, waiting until rates rise and premiums drop to buy a new policy would be a better bet. But if an adjustable policy is fairly priced, he says, it should beat buying a new policy later on.
Further, a client who buys adjustable insurance today will always have premiums based on her age at time of purchase. Someone who signs up for a new policy when premiums drop in future will be older when her payments are calculated, he notes. While the difference in premiums would be slight, adjustable would have the advantage.
The price of cancelling existing policies may deter some customers, but as time passes, the force of these penalties fades and in some cases disappears, says Innes.
The benefits of many whole life policies, such as cash values, aren’t activated until between the second and fifth years of a plan. Universal life plans have surrender charges for early cancellations. But the more years the policy is in force, the fewer people these deterrents will affect, he notes.
Burned by the plans in the past, some advisors will be more reluctant to embrace adjustable policies than consumers, says McKay. Many advisors who saw those premiums go up years ago are still practicing, he says, but a new generation of consumers is in the market. It’s a matter of re-educating advisors, he says. “We’re now in a very different environment […] Really, interest rates only have one way to go, and that’s up.”
Advisors may also feel they’re doing themselves a disservice by promoting adjustable insurance, as the policies preclude the possibility of re-signing clients when the interest rate changes. But advisors shouldn’t think that way.
A higher interest rate will bring other opportunities for sales as inflation erodes policies’ face values, says Pereira. “They’re probably going to need more insurance anyways, and another policy,” he explains.
Advisors shouldn’t feel entitled to signing commissions, adds Innes. “To say that the advisor is losing out, I have a hard time buying that. He’s missing out on a windfall, but the windfall wasn’t his in the first place,” he says.
And, he adds, it’s early times.
“There will be better and better versions of these coming out, more innovation, and more accountability to the consumer,” he says.
Many companies have given little thought to adjustables beyond hallway discussions, but if early policies catch on, competitors will take notice.
Pereira says there’s a place in the Canadian market for adjustable policies, but he’s cautious about their prospects.
“It’s definitely not going to overtake the existing policies out there,” he says.
“I don’t think people are going to be sold on this concept of interest rates. That’s all background noise. What they’re going to care about is the price: that’s the key selling point.”