Replacement Vulnerability of Older Nonparticipating Ordinary Life Insurance Policies

Abstract

Many life insurers have introduced new, lower premium nonpar policy series over the past few years. This action is alleged to have caused many older nonpar policies to appear vulnerable to replacement by these and other new policies. This study analyzes some of these older policies and concludes that many of them are vulnerable to replacement. It further suggests alternatives to insurers as to how to cope with this potential replacement problem. Many major stock insurers selling nonparticipating life insurance have introduced new, lower premium policy series over the past 20 years. This trend is illustrated in Table I which shows the 20-year net payment cost and surrender cost indexes (at 5 percent) for $10,000 and $100,000 nonparticipating ordinary life insurance policies issued by several major stock life insurers to 20, 35, and 50 year old males.' The downward trend in the net payment cost and surrender cost indexes is clear, especially for the $100,000 policy size. The percentage declines from 1958 to 1978, shown in parenthesis, dramatize the magnitude of the decreases over this period. The increase in investment earnings experienced by insurers over the past few years, particularly within the past 10 years, is a major cause of lower net payment cost and surrender cost indexes. Also contributing to this downward trend is an improvement in mortality and changes in non-forfeiture and reserve laws allowing more liberal interest assumptions and, since 1958, more liberal mortality assumptions. Moreover, perhaps increased competition through price disclosure has contributed to the trend. But the focus of this paper is on the effect of this trend, not its cause. Harold Skipper, Jr. is Associate Professor of Insurance at Georgia State University. He holds the Ph.D. degree from the University of Pennsylvania. Dr. Skipper also is a C.L.U. Professor Skipper was a Fellow of the S. S. Huebner Foundation and serves (or is currently serving) as consultant, Privacy Protection Study Commission, consultant, President Carter's Privacy lnitiative and member, National Association of Insurance Commissioners Advisory Committee on Manipulation in Life Insurance. 'The net payment cost index represents the average annual net outlay (premiums less dividends, if any) for a life insurance policy over a stated number of years (e.g., 20), recognizing the time value of money. For a nonparticipating, level premium policy, the net payment cost index equals the annual gross premium. The surrender cost index is an approximation of the average annual cost of a life insurance policy over a stated number of years, recognizing the time value of money and assuming the policy is terminated for its cash value (if any) at the end of the stated time period.