Five months ago, the lives of millions of Americans were jolted into a new reality as a result of the global pandemic. The effects of the novel coronavirus continue to ripple through virtually every part of our lives: the health and welfare of family and friends, economic hardship, market volatility, racial inequality discussions, and at home work and learning are just the start of life in the “new normal”. As with the rest of the world, the impact of COVID-19 on the life insurance industry was rapid, severe and disruptive; while some of the immediate effects have started to dissipate, there will be longer term implications to insureds and insurers.
Before delving into some of the specific areas of change, it is important to note that the U.S. life insurance industry is well capitalized and heavily regulated. In pre-pandemic times, updates to underwriting requirements and product pricing changes were announced weeks or months before the changes were set to take place. Clear transition guidelines were published and a runway was established for life insurance professionals and clients to take action in measured but timely fashion.
The marketplace’s reaction earlier this year was nearly immediate – several of the largest insurance carriers announced new underwriting guidelines or product restrictions that would take effect at the end of the business day or would release notice on Friday to take effect on Monday. The designing, qualifying and implementation of a life insurance strategy is a multi-step process coordinated between various entities. Clients and their advisors adapted to changing conditions as well as possible, understanding that plans either had to be accelerated and/or postponed.
Through this difficult time life insurance has continued to be an essential planning tool that brings emotional and economic security to individuals, families and businesses. A review of long existing procedures and requirements and the necessity of change will lead to positive changes and push innovation in the marketplace. The steps taken by the insurance providers were to minimize their exposure to known (and uncertain risks) as a means to protect existing and future consumers.
The balance of this article will highlight the key changes and collateral effects caused by COVID-19 on the life insurance marketplace and discuss the longer-term ramifications on the industry and the people it serves.
Medical Qualification and Underwriting Requirements
COVID-19 is a health crisis. Life insurance is, of course, a financial instrument that is based upon the mortality of an individual and therefore requires medical qualification to be acquired; this is a unique characteristic among other asset types.
Early in the crisis, the life insurance industry placed significant “blanket” underwriting parameters based on the reasoning that, if infected with the virus, certain classes of individuals would be more susceptible to negative outcomes.
Most carriers (as directed by their reinsurance partners) postponed clients over a certain age threshold as young as Age 70. These postponements took effect immediately regardless of where the potential insured was in the process and their health status. While some carriers have held the line to Age 70, many providers have relaxed the limit to Age 80 (and issued coverages to insureds 70-79 that were temporarily postponed).
Similarly, “rated” or “sub-standard” insureds, individuals with pre-existing medical impairments that would require additional premium cost for coverage to be written, were also immediately postponed and subsequently the guidelines were relaxed to varying degrees. Individuals with specific underlying medical conditions such as heart disease, diabetes, autoimmune disorders or taking any medication that causes immunosuppression are now being evaluated on a case-by-case basis.
Carriers that offer underwriting enhancement or bonus programs that improve rate class based on product selection or a crediting system for positive health attributes suspended these advantageous programs and have been slow to reinstate them.
From a procedural standpoint, COVID-19 greatly affected the way in which an individual completed the medical exam and fluid testing requirement. Historically, most situations required a person to have an examiner come to their home or place of business to conduct a limited physical and provide blood and urine samples. Along with the safety concerns of the proposed insured, exam services limited appointments in certain regions to protect their employees.
Insurance companies that were positioned to utilize technology and accelerated underwriting programs, such as John Hancock and Penn Mutual, were able to continue to process business much more efficiently. The life insurance industry has as a whole has been slow to embrace technological innovation. Penn Mutual’s Accelerated Client Experience (ACE) was piloted in 2017 and has again traction over the past three years. For healthy insureds under the age of 65 for up to $5,000,000 of coverage, it is possible to complete an online application and have an actionable underwriting offer without the need for an exam in a matter of moments. The policy can be electronically delivered and payment made through a secure portal. The completely electronic process can be completed in a matter of days. Several carriers are now expanding or improving their online or tele-app capabilities while phasing out the need for an insurance-specific exam if the proposed insured completed a full “executive” physical over the last 12 to 18 months. These streamlined underwriting improvements will continue to make the qualification and purchasing process more client-friendly.
In addition to medical underwriting changes, COVID caused increased restrictions on foreign travel leading to postponements for individuals visiting China or Europe. The postpone periods ranged from 14 to 90 days depending upon country visited, and some providers required a doctor visit to confirm no symptoms or active virus.
An individual with a positive COVID diagnosis is able to acquire coverage after 30 days from full recovery and medical records confirming no evidence of current infection and health status has returned to previous levels. Individuals with known exposure to the virus are also postponed for 30 days. Several insurance companies have added a requirement after approval but before a policy has been issued that the insured has not contracted or been exposed to the virus.
After a significant and immediate response to the virus, medical underwriting guidelines and the process for qualifying for insurance has begun to relax back to previous levels. The need for streamlined requirements and reliance on electronic procedures may prove to be a beneficial catalyst going forward. The requirements and procedures of each individual insurance company underscores the need for any potential buyers and their advisors to review not only the features of a policy and its price, but also what requirements and limitations are in place for qualifying.
Low Interest Rate Impact Product Pricing and Availability
The economic impact of the coronavirus has been felt across nearly all industries, including the life insurance marketplace. The decision to lower to the Federal Funds Rate to near zero has significantly influenced changes to insurance product pricing and availability as well as negatively impacted existing policy performance.
As a highly regulated industry, insurance companies invest their General Account primarily in high-quality bonds and other fixed income-like investments, such as commercial mortgages. The yield earned on this General Account is passed back to consumers (minus spread for profitability) through interest crediting rates or dividends – in this way, the flow of money for an insurance company is very similar to a bank. The historically low interest rate prior to COVID was already asserting negative pressure on General Account yields which will be amplified by the further reduction of ambient interest rates and increase reinvestment risk.
The industry response to the economic factors - the initial market volatility and interest rate reduction – coupled with uncertainty of the long-term morbidity and mortality effects of the virus was again rapid. Almost immediately, carriers announced reductions in interest crediting rates, dividend rates and index caps for existing and new policies. Below is a brief summary of how the three primary General Account supported policies are linked to interest rates.
Participating Whole Life: Policies are credited dividends based on the overall profitability of the issuing company, including the return on the General Account and mortality. Historically, dividend rates are correlated to the interest rate environment. Mutual companies tend to be the only providers of participating whole life and we expect to see a continuing trend of decreased dividend rates.
Current Assumption Universal Life: Policies are credited interest based on the investment earnings of the General Account. The “cost” of the policy are the underlying Cost of Insurance charges which are deducted from the cash value on a monthly basis. While companies can adjust the cost of insurance changes (up to a contractually guaranteed maximum), a reduction of interest crediting rates are most likely to occur first.
Indexed Universal Life: Policies are credited an interest rate based upon a segment of time (generally 12-months) based upon the performance of a widely available Index. While the crediting rate is reflective of the Index used, the cash value is part of the General Account and not directly invested in the Index. These policies feature a guaranteed floor (0% or 1%) and have a non-guaranteed cap. The floor and caps are funded by the insurance carrier buying equity call options; the primary funding source for this hedging strategy is the General Account investment return.
Unlike the direct association of the medical impact of COVID (again noting that we do not know the long-term effects on mortality and the subsequent changes to profitability), these crediting factors directly affect existing policies. Inforce policy performance is and will continue to be negatively affected due to the low interest crediting rate environment. For policy owners and their advisors, policy reviews should be conducted at regular intervals and especially so in the current environment. In addition to running inforce illustrations (projections of policy performance) at current rates, it is advisable to run accompanying illustrations at reduced crediting rates to analyze the potential of further performance erosion.
The type of life insurance that has been most impacted by the low interest rate environment is Guaranteed Universal Life. Unlike the previously detailed policy types, Guaranteed Universal Life provides a contractual guarantee between the premiums paid and a death benefit; policy performance does not adjust over time due to non-guaranteed factors such as crediting rate or cost of insurance charges. This type of policy requires significant reserve requirements from insurance carriers and is, by design, inflexible for both the policy owner and the issuing company. In the environment exacerbated by COVID, many carriers have either dramatically increased pricing for new policies (so as much as 20% per year) or have decided to discontinue the product line all together. In many cases, insurance carriers are adding shorter duration secondary guarantees to the aforementioned General Account policies and Variable Universal Life policies to be discussed next.
These changes to General Account policies have caused an increased use of Variable Universal Life policies. Variable Universal Life cash values are not invested in the company’s General Account, but in a Separate Account. The investment risk is borne by policy owner who selects from a menu of available equity and fixed income mutual fund analogues (Insurance Dedicated Funds). Other than potential changes to the underlying Cost of Insurance Charges, the low interest rate environment has less of a direct impact on policy performance. However, these policies are subject to daily market volatility.
An additional action many insurance carriers have adopted is to limit either the amount of coverage or implement initial premium threshold limitations. Though at first it seems counterintuitive to limit the amount of premium received, these limitations protect the insurance company from having to immediately invest large amount of money at low interest rates. This size restrictions applies to external 1035 Exchanges, where the cash value from one policy under Insurer A can be transferred, tax-free, directly to Insurer B. This is particularly important at a time when existing policies may be underperforming due to the crediting rate or insurance charges in the current environment.
We do not know the full consequences of COVID-19 and what lasting changes will come to the life insurance marketplace. The life insurance industry has provided death benefit protection for over 200 years and will continue to meet its obligations. With uncertainty about interest rates and market volatility, along with potential changes in tax law, life insurance will remain a vital asset class that provides individuals with more than just death benefit protection. The enormous shockwaves caused by the pandemic reinforce the need and benefits of a well-designed and monitored insurance portfolio.
Michael C. DeFillipo, CLU, ChFC, is a Partner of 1847 Private Client Group, in Conshohocken, PA. Michael has 15 years of experience working with high net worth clients and their advisors designing, implementing and monitoring sophisticated life insurance portfolios. 1847 Private Client Group is an owner firm of Lion Street – an exclusive national network of elite financial firms.