Return of Premium Term Rates: Are They On The Rise?

First, insurers must hold reserves equal to cash values if the reserve calculated is less than the cash value. Most companies probably have reflected the cost of holding these additional reserves in their pricing calculations.

Second, section 6D"Unusual Pattern of Guaranteed Cash Surrender Values"of the National Association of Insurance Commissioners Valuation of Life Insurers Policies Model Regulation (Regulation XXX) applies. It requires a company to hold additional statutory reserves if the cash value pattern is steep, which is typical for ROP term. The additional reserve is calculated assuming the ROP benefit is a pure endowment. These additional reserves can be quite substantial. Not all companies have included the cost of holding these additional reserves in their pricing calculations.

Reinsurance: Term insurance is frequently coinsured. This allows insurers to decrease the amount of reserves held. The ROP portion of the term product is seldom reinsured, however. This can lead to a loss of reserve credits on the non-ROP portion of the ROP term policy, especially in the later durations of the policy.

Interest Rate Assumptions: Since the ROP portion of the term policy is seldom reinsured, the interest rate assumptions become more important than in term policies that are reinsured. However, there is a risk that the issuing ROP company might overlook this importance. In addition, because ROP term requires higher reserves, its profitability is more sensitive to interest rates than non-ROP term. Decreasing the interest rate assumption from 6% to 5% requires an increase in premium rates of about 12% to maintain the same level of profitability in the above example involving the 40-year-old man.

Other Lapse Rate Issues: Since ROP term has higher premiums than term without ROP, and since no additional benefits are provided in the early durations, lapse rates for ROP term in the first few policy years are likely to be higher than term without ROP. These additional lapses could occur before acquisition costs have been recovered. Some data on this exists, but it is not sufficient to confirm that conclusion.

Some insurers assume that a fraction of policyholders will persist beyond the level term period. These insurers generally assume that the annual renewable term premiums after the level term period are sufficient to cover the death benefits that arise from persisting policyholders. Since the ROP benefit typically does not accumulate premiums after the level term period (in some cases, the ROP benefit expires at the end of the level term period), fewer ROP term policyholders are likely to persist beyond the level term period, decreasing profitability.

Companies that have not taken these factors into account in pricing could see significant increases in ROP term premium rates.

However, the wide range of ROP term premiums in the market today is evidence that some insurers are taking these pricing issues into account. Will other companies follow suit?

Nik Godon, FSA, FCIA, MAAA, is vice president and product actuary with AEGON USA in Cedar Rapids, Iowa. His e-mail address is [email protected]. Dominique Lebel, FSA, FCIA, MAAA, is a consultant with the Tillinghast business of Towers Perrin in Hartford, Conn. His e-mail address is [email protected].

Reproduced from National Underwriter Edition, June 4, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.