022bk Life06

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Incorporating Policyholder Behavior in Pricing Life Insurance Products

Society of Actuaries Spring Meeting, Session 22 PD Hollywood, Florida
Dominique LeBel (860) 843-7161 May 24, 2006

SPL022Lebel
2006 Towers Perrin
Agenda
Disclaimers Approaches to Lapsation and Mortality Assumptions after the Level Term Period Shock Lapse Rates Initial Excess Mortality Excess Mortality in Later Durations Lapse Rates after the Level Term Period Profits Beyond the Level Term Period Impact of Return of Premium Riders on Ultimate Lapse Rates
SOA Life 2006 Spring Meeting 22PD, Incorporating Policyholder Behavior in Pricing Life Insurance Products
Disclaimers Anti-Trust Disclaimer This presentation pertains to what has been observed in the past, not to future pricing actions Predicting policyholder behavior requires judgment. Many actuaries have different views
Pricing Term Insurance

Possible Options Price only over level term period (i.e. assume lapse rate is 100% at the end of the level term period) Very common (perhaps 50% of direct writers) for pricing term Viewed as conservative Less common for securitizations, embedded values and appraisals Concerned with the right answer Assume that the lapse rate is less than 100% at the end of the level term period Perhaps 50% of direct writers, higher proportion of reinsurers
Shock Lapse Rates

Level of the shock lapse rate is important Although it might seem like there is not much difference between a 90% shock lapse rate and a 95% shock lapse rate, a 90% shock lapse rate results in twice as much business remaining after the level term period Limited experience exists Shock lapse rates should be a function of the size of the premium increase Some companies grade the shock lapse assumption over more than one year A lapse assumption of 65%, 45% and 25% implies a three year lapse rate of 86% which is equivalent to assuming 80% followed by 2 years of 15% The Product Development Section is sponsoring a research project on post level term period lapse and mortality experience
Initial Excess Mortality

Two Options: Use an anti-selection formula Use higher mortality factors A variety of assumptions are used
Anti-Selection Formulas
Dukes/MacDonald or Becker/Kitsos (or versions of them) are commonly used to calculate or justify mortality anti-selection Formulas typically use the concept of conservation of total deaths Inforce population before lapse divided into four groups: Base lapsers Select excess lapsers Non-select excess lapsers Inforce persisters
Anti-Selection Formulas (continued)

Versions differ on which group the excess mortality is spread over. Three versions are presented below:
Versions of Anti-Selection Formulas
Group Base Lapsers Select Excess Lapsers Non-select Excess Lapsers Inforce Persisters Version 1 Point-in-scale Select Point-in-scale Excess Version 2 Point-in-scale Select Excess Excess Version 3 Excess Select Excess Excess
Can appear unrealistic for: High issue ages Due to difference between select and ultimate mortality High lapse rates Due to spreading excess mortality over a small number of persisting lives
Anti-Selection Formula Example

Model Point: 20 Year Term Mortality Table: q [40]+20 q [60] 8590 ANB 10.357 3.284 Male Non-Smoker Issue Age 40
Base lapse rate = 10% Proportion of lapses in excess of base that are select (sometimes called effectiveness) = 80% Total lapse (includes base lapse) = 85%
Anti-Selection Formula Example (continued)

Baseline Assumption Results
Group Base Lapsers Select Excess Lapsers Non-select Excess Lapsers Inforce Persisters 10% 60% 15% 15% 100% Version 1 10.357 3.284 10.357 38.649 10.357 Version 2 10.357 3.284 24.503 24.503 10.357 Version 3 20.967 3.284 20.967 20.967 10.357
Mortality Ratio for Persisters Relative to Point-In-Scale Mortality
373%
237%
202%
Differences are significant!
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Anti-Selection Formula Example (continued)

Sensitivities
Mortality Ratios Version 1 Baseline Assumptions Base Lapse Rates Increase to 15% Proportion of Lapses in Excess of Base that are Select Increases to 85% Total Lapse Rate Increases to 90% 373% 355% 390% 537% Version 2 237% 232% 266% 268% Version 3 202% 187% 220% 221%
As the shock lapse increases, the initial excess mortality increases, resulting in additional decreases in profits beyond the level term period The proportion of lapses in excess of base that are select would be expected to decrease as the shock lapse rate increases, since if everyone lapses it would seem reasonable for lapsers to exhibit point-in-scale mortality
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Loss Ratios
Can look at loss ratios to see if initial excess mortality is reasonable For example, assume that the annual renewable term premium beyond the level term period is 200% of 1980 CSO, which is about 210%-220% of the 75-80 ultimate mortality table for male non-smokers with attained ages between 50 and 70 Assume that the non-smoker mortality assumption is 40% of the 75-80 table A shock mortality assumption of 200% results in a loss ratio of 80/215 = 37% A shock mortality assumption of 300% results in a loss ratio of 120/215 = 56% A shock mortality assumption of 400% results in a loss ratio of 160/215 = 74%
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Excess Mortality in Later Durations

Less critical assumption than the shock lapse and initial level of excess mortality Question: How does the excess mortality grade off? Again, a variety of assumptions are used: Grade to ultimate assumption greater than standard Makes sense if believe further anti-selection Grade to 100% of standard Use anti-selection formula May result in pattern that is not smooth
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Lapse Rates After the Level Term Period

Limited experience exists Lower lapse rates after the level term period are usually associated with higher shock lapse rates
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Profits Beyond the Level Term Period

Largely a function of post-level term period premium, lapse and mortality rates Given the uncertainties surrounding assumptions beyond the level term period Do not use significant amount of profits beyond the level term period to support level term period premium rates Sensitivity tests Shock lapse (including 100% shock lapse) Initial level of excess mortality Lapse rates beyond level term period As companies switch to 2001 CSO, annual renewable term premiums are lower and mortality assumptions have not changed much, so the sometimes large profits that are projected after the level term period will be reduced
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Impact of Return of Premium Riders on Ultimate Lapse Rates

More lapse supported than level term Ultimate lapse rate is key assumption A variety of assumptions are used No ROP Term experience exists Look at Canadian Term to 100 experience (published in 1999), Canadian Universal Life Level Cost of Insurance experience (published in 2003) and US Long Term Care experience (published in 2004) Lapse rates by number of policies and sum insured are presented on the next slide A new Canadian Term to 100 and Universal Life Level Cost of Insurance lapse study is expected to be published later this year
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Canadian Lapse-Supported Lapse Experience

Ultimate lapse rates range from 1% to 2% for the Canadian studies and from 3% to 4% for the longterm care study
Lapse Rates by Number of Policies and Sum Insured
12.0%
10.0%
8.0%
Te rm to 100 # o f P o lic ie s
6.0%
Te rm to 100 S um Ins ure d UL Le ve l C OI # o f P o lic ie s
4.0%
UL Le ve l C OI S um Ins ure d Lo ng-Te rm C a re (Individua l a nd Gro up P la ns C o m bine d)
2.0%
0.0% 1 3 5 7 9 11 13 15 Policy Year

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Long Term Care Lapse Experience

Long-term care practitioners generally do not use the results of the above long-term care lapse study for all issue ages combined to set ultimate lapse assumptions. Instead a more granular review leads to results more similar to the study for issue age groups 50 to 59 and 60 to 69, where ultimate lapse rates are in the range of 1.5% to 2.5%, which are expected to be more indicative of future experience.
Long-Term Care Lapse Rates by Issue Age Group (Individual and Group Plans Combined)
7.0%
6.0%
5.0%
4.0%
50 - 59 60 - 69
3.0%
2.0%
1.0%
0.0% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Policy Year
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Setting Lapse Rates for ROP Term

The results of these studies indicate that the Canadian and U.S. longterm care markets are not unsophisticated Rather these markets understand the value of the options in lapsesupported products and the significant internal rates of return that are foregone upon lapse It would seem reasonable to assume that the return of premium term market is (or will be) as sophisticated and to use these lapse study results as a starting point to set lapse rates Although ultimate lapse rates may not be statistically credible in later durations, it is difficult to ignore them
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Session 22 PD
Incorporating Policyholder Behavior In Pricing Life Insurance Products

Dan Theodore, FSA
Society Of Actuaries 2006 Life Spring Meeting May 24, 2006
Topics
1. 2. 3.
Economic Scenarios Term Conversions Life Settlements
Economic Scenarios
General Comments Pricing For Economic Scenarios UL with Secondary Guarantees Principles-Based Reporting
Economic Scenarios General Comments

Usual Suspects Embedded Options Used for EV and CFT More Common to Annuity Pricing than Life
Pricing For Economic Scenarios

Sensitivity Testing More Typical Some Stress Testing to Find Limits New York 7 Pre-set range of Scenarios Stochastic Modeling
UL with Secondary Guarantee

Aggressive Products Need Testing Economic Reserves AXXX Securitizations
Principles-Based Valuation
Industry Goal: Eliminate Excessive Margins Capture Previously Unpriced Risks Increased Costs Altered Policy Provisions
Term Conversions
Considerations 1. Product Focus 2. Ease and Marketing Of Conversion 3. Pricing Considerations 4. Experience
Company Marketing Focus

Term Sales Permanent Sales Conversions Other Life Products Other Non-life Products
Ease and Marketing of Conversion

Term Conversion Periods Available Products Last Conversion Date Conversion Credit Planning Conversion At Time Of Sale Direct Mailings To Policyholders Follow-ups By Agents To Policyholders More Limited Term Conversion Period Fire Sales Special Offers To Policyholders and Agents
Pricing Considerations
Expected Conversion Rates Expected Post-Conversion Mortality
Expected Post-Conversion Mortality

Point-In-Scale ( q[x]+t ) Anti-selection At Premium Increase Experience-Based Assumption SWAG Formula-based Dukes-MacDonald Becker-Kitsos
BUT HOW TO SET UNDERLYING RATES?
* Session 63 at the 2005 Life Spring Meeting http://handouts.soa.org/conted/cearchive/NewOrleans-May05/063_bk.pdf http://library.soa.org/library-pdf/rsa05v31n163pd.pdf
Pricing Considerations
Expected Conversion Rates Expected Post-Conversion Mortality Expected Post-Conversion Persistency Reinsurance Reflecting Conversions in Pricing
Reflecting Conversions in Pricing (1)

Who Bears The Cost Of Conversion?
Term Permanent Shared
Early Perm Late Term Everybody Nobody?
Reflecting Conversions in Pricing (2)

Price Permanent Policy - New Issue vs. Conversion
Conversion Policy Reflects: Higher Mortality Lower Expenses Better Persistency?
Conversion Single Premium

Difference in PV B/T Profit PV Capital Flow PV Distributable Earnings Varies By Attained Age And Duration
Experience
Conversion Rates
Up to 2.5% Annually of Eligible Term Much Higher at Last Chance (Reminder?)
Mortality
No Industry-Wide Study Few Companies Have Sufficient Volume Possible Trends
Products
Are there conversion products that offer longer
periods for the same or less premium?
Waiver of Premium on Term

Disability Prior to Last Conversion Date Automatic Conversion At Later Of:
Last Conversion Date End of WP (Age 60 or 65)
WP Pricing Reflects Permanent Premium
Life Settlements
Whats Happening? Effect on Mortality and Persistency Products Most Affected Reinsurance Implications Where is it going?
Life Settlements Whats Happening?

Just Barely On Radar Two Broad Categories
1. Traditional Transfer of Inforce Policies 2. Premium Financing
Traditional Life Settlements

Derived From Viaticals Fast Growing Market Policies Most Affected Effect on Experience Insurer Responses Alternate Responses
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Premium Financing
What Is Included Here? Where Are They Coming From? How Can This Work? Products Most Affected Application and Underwriting
Premium Financing - Results

Pricing Effect Effect on Mortality and Persistency Reinsurance Implications Economic Underwriting
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Life Insurance Life Annuity Combos

LILACs Charity-Owned Life Insurance Created by a Life Insurance Broker Investor-Driven
LILACs How they work

Outside Investor Provides Single Deposit
Promised Fixed Rate of Return
2 Separate Issuers of Annuity and Life Policy

SPIA Purchased on Donor Life
Monthly Annuity Income Pays Coupons Remainder Purchase Life Insurance on Donor (Death Benefit Exceeds Principal) At Death, Charity Receives Excess DB
Term of Asset Unpredictable

Depends on Death of Insured
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LILACs Concerns
Insurable Interest vs. Wagering Tax Exemption of Charity? Parties to Transaction

Selling Agent Makes Commission Investor Makes Bet on Sure Return SPIA Issuer Makes Mortality Bet Life Insurer Makes Mortality Bet Charity Receives Excess Benefits
Can Everyone Make Money?

Someone Must be Wrong Maybe More Than One
Questions?
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Thank You for Listening
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1

Incorporating Policyholder Behavior in Pricing Life Insurance Products

Dominique LeBel (860) 843-7161 May 24, 2006

Pricing Term Insurance

Shock Lapse Rates

Initial Excess Mortality

Anti-Selection Formulas (continued)

Anti-Selection Formula Example

Anti-Selection Formula Example (continued)

Mortality Ratio for Persisters Relative to Point-In-Scale Mortality

Differences are significant!

Anti-Selection Formula Example (continued)

Excess Mortality in Later Durations

Lapse Rates After the Level Term Period

Profits Beyond the Level Term Period

Impact of Return of Premium Riders on Ultimate Lapse Rates

Canadian Lapse-Supported Lapse Experience

Te rm to 100 S um Ins ure d UL Le ve l C OI # o f P o lic ie s

UL Le ve l C OI S um Ins ure d Lo ng-Te rm C a re (Individua l a nd Gro up P la ns C o m bine d)

0.0% 1 3 5 7 9 11 13 15 Policy Year

Long Term Care Lapse Experience

0.0% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Policy Year

Setting Lapse Rates for ROP Term

Incorporating Policyholder Behavior In Pricing Life Insurance Products

Society Of Actuaries 2006 Life Spring Meeting May 24, 2006

Economic Scenarios Term Conversions Life Settlements

Economic Scenarios General Comments

Pricing For Economic Scenarios

UL with Secondary Guarantee

Company Marketing Focus

Ease and Marketing of Conversion

Expected Post-Conversion Mortality

Reflecting Conversions in Pricing (1)

Early Perm Late Term Everybody Nobody?

Reflecting Conversions in Pricing (2)

Conversion Single Premium

periods for the same or less premium?

Waiver of Premium on Term

WP Pricing Reflects Permanent Premium

Life Settlements Whats Happening?

Traditional Life Settlements

Premium Financing - Results

Life Insurance Life Annuity Combos

LILACs How they work

2 Separate Issuers of Annuity and Life Policy

Term of Asset Unpredictable

Can Everyone Make Money?

Thank You for Listening

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