Life insurance can be valuable for many reasons – settling any outstanding expenses a person may have at the time of death, providing funds for a person’s burial or funeral, and providing some cash flow to a family upon the death a breadwinner. Not everyone needs life insurance, but for many people, it would be a powerful tool in reducing the financial burden left on the living by a deceased person.
Types of Life Insurance
Briefly, we’ll lay out three major types of life insurance sold in the retail/individual market for context. The focus of this paper, however, is term life insurance.
|TYPE OF LIFE INSURANCE||Term||Whole||Universal|
|Premiums||Contractually required periodic payment||Contractually required periodic payment||No required contractual premium payment; policyholder decides when they want to make deposits|
|Charges||Mortality and expense costs bundled into contractual premium||Mortality and expense costs bundled into contractual premium||Mortality and expense costs explicitly deducted from account value|
|Death Benefit||Set amount||Set amount||Can be set amount or set amount plus account value/paid premiums|
|Cash/Account Value||No cash or account value||May have cash value to which interest is credited||Has account value which is increased by policyholder deposits and interest crediting, decreased when charges are deducted|
|Lapse||Policy terminated with missed premium payment||Policy terminated with missed premium payment||Policy terminated when account value reaches 0, or no-lapse provisions are not met|
Presently, when a person purchases a term life insurance product, they are required to pay a premium periodically to keep their policy in force. If a policyholder fails to make a premium payment, they may be given a grace period (typically 30 or 60 days) to make their payment. Failure to pay even after the grace period will result in terminated coverage (they “lapse”).
From the insurer’s perspective, this actually isn’t a bad thing. They’ve received a number of premium payments to cover a liability that will no longer come due. Releasing the reserve that was held for that policy reduces the policyholder liability on the balance sheet, and has a positive impact on the income statement. Further, the insurer has probably invested the premiums they’ve received from the policyholder, so they’ve earned additional income.
However, life insurance contracts are long, and life happens. People lose their jobs. Medical bills arise. Family members who’ve hit hard times need to be bailed out. Insurance premiums don’t rise to the top of the list of things that need to be covered. Sometimes, waiver of premium provisions can address reduced ability to pay, but may not be offered on all products, can make coverage more and are typically used to address disability or illness.
I’ve listened to individuals who’ve literally said that they’ve told their friends to cancel their life insurance policies because the life insurance companies will cheat them and cancel their policies if they lose their job. While this isn’t exactly the case, it’s not difficult to understand how a policyholder might perceive this to be the case. As a practitioner in insurance, I find myself frequently asking how we might build products that are more empathetic and responsive to the multitude of circumstances people encounter in their lives.
Novel Feature: Benefit (Face Amount Reduction)
What if a carrier reduced the benefit amount when policyholders missed premium payments to reflect the fact that cumulative premiums would be insufficient to cover expected benefits and expenses through the duration of the policy? The idea is that after a premium payment is missed, the benefit amount would be reduced using some function of the accumulated premium paid to date relative to what the insurer would have expected by that time from issue. This could mean simply tracking face amount against some function of accumulated premium, such that the benefit amount changes every period, or initiating permanent reductions in face amount for every missed premium payment.
For the actuaries that might be reading this, or anyone interested in some of the technical aspects, we built a model where the policy reserve and benefit adjustments were modeled using the retrospective reserve method. We should also note that our model does not necessarily reflect any statutory reserving requirements, but is simply a first principles reserve calculation. Additionally, we do not assume that expenses (which we should mention, are not based on any administrative model but included to allow for that capability) are adjusted downward after the benefit is reduced, so a there may be instances where coverage might be reduced, but the policy reserve goes negative (negative reserve indicates that the company has paid out more on the policyholder’s behalf – benefits, expenses – than they have received from the policyholder – premium) before the end of the level term period.
Below, we share a few examples of how a coverage reduction on a term insurance product might be executed. These examples are all based on the model we’ve used to sketch out this concept:
- Face amount reductions but termination if reserve goes negative rather lapsing the policy in the period after the premium is not paid:
- 10-year, $60,000 coverage on a 25-year-old female
- Premium is not paid in the 7th month of the 6th year of a 10-year term policy; coverage reduced to $59,199.05
- The policyholder continues to pay premiums after this point in time; coverage gradually continues to approach the original death benefit amount as premiums are paid and the proportion of accumulated premium actually paid relative to what would have been scheduled to be paid at issue moves closer to 100%
- The reserve goes negative at the end of the 8th month of the 10th year, 4 months prior to the end of the level term period
- The policy lapses in month 9 of year 10, because the reserve has gone negative (assuming no catch-up premium is paid in the grace period)
- Permanent Reductions in Face Amount – in an effort to prevent the reserve from going negative, as well as reimbursing the policyholder for any funds they pay into the policy (premiums) in excess of the amount the insured would expect to pay on their behalf (benefits and expenses)
- 25-year old female policyholder purchases a 10-year, $60,000 coverage for $7.73 per month
- The policyholder misses premium in the 8th month of the 4th year (month 44); their coverage is modified to $55,084.05
- Modified Face Amount = (AV PremiumsActual (T=44) / Av PremiumsScheduled (T= 44))4 * Original Face Amount
- The policyholder makes all of the other payments, their coverage remains at $55,084.05 for the remainder of the level term period
- A reserve of $19.43 is left at the end of the level term period
- $19.43 is reimbursed to the policyholder
Our final example is one where we demonstrate what could be done in the event that a policyholder misses multiple premium payments.
- A 30-year-old woman purchases a simplified issue, 8-year (96-month) Term Life Insurance policy for $60,000 at a monthly premium of $8.70
- She falls on hard times at a few points during the level term period and doesn’t pay premiums at these points:
- 10th month of the 2nd year (22nd month)
- 10th month of the 4th year (46th month)
- 11th month of the 4th year (47th month)
- Her coverage is reduced at the following points to the levels listed below:
- 10th month of the 2nd year (22nd month) – $50,140.96
- 10th month of the 4th year (46th month) – $46,220.21
- 11th month of the 4th year (47th month) – $42,686.53
- At the end of the 10-year level period, she is reimbursed $74.70 to reflect the excess of the amount she paid into the policy compared to what the insurer would have expected to pay and spend on her behalf
- AV (Premiums) – AV (Benefits + Expenses)
We believe that multiple stakeholders win in this type of scenario. Here are some of the ways:
- Security – Allows policyholder to feel secure that they will not have coverage “pulled from under them” particularly in times when they feel vulnerable and may be unable to pay premiums
- Trust – Policyholders feel like they have paid money for nothing when a policy lapses, explaining the coverage reduction—particularly why it’s done—and keeping policyholders in-force may help combat the perception that they might be “tricked” or “screwed” by the insurance company
- Simplicity – Does not create additional complexity or additional cost for policyholder through waiver (What qualifies? What doesn’t qualify? What documentation do I need? How long before the waiver takes effect?)
- Risk Management – Allows the company to reduce exposure without alienating policyholders
- Goodwill and Lifetime Value
- Could open up new market segments and drive long-term value with a new populace
- People may actively see insurers as trying to “help” them or “work with them” during times of hardship
- Could help with cross-selling offerings which address other financial needs
- Could be the beginning of graduating consumers to new and more complex products as their situations become more complex
Our model, which calibrates face amount adjustments, can be made publicly available if there is enough interest. Its main purpose is to allow a user to visualize how missed payments at various points over the level term period lead to coverage reductions.
We hope this paper will advance discussions on how the life insurance industry might meet the needs of a greater number of consumers. There may also be an opportunity for similar types of product modifications in the property and casualty space, particularly as those products cover risks that are more tangible to consumers. The current pandemic is illuminating the struggles of so many Americans and people around the globe and highlighting the gap between folks who have tools and mechanisms to absorb the economic impacts of this shock, and those who do not. The death of a family member, particularly during this time, is not only emotionally difficult but may present additional financial difficulties for those without means to readily bury their loved ones and deal with final expenses. Reduced cash inflows for households may limit the effectiveness of crowdfunding for such expenses during this time. Adaptations and evolutions in the design and delivery of life insurance may help to close that gap not only now, but also as we emerge from this crisis and people begin to recover from the pain that they’ve experienced in recent months.