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If we insist on marketing private placement life insurance as an investment, relying largely on the benefit of sometimes anachronistic and often-changing tax law to give us the edge over non insurance competitors, we invite questions about the integrity of our game and the slant of the playing field. And as we do so, we open an avenue of our own creation that Congress will travel in its quest for revenue sources.
The 1990s witnessed some of the industry's worst experiences, and an amazing amount of that can be traced to its attempts to force investment formulas and results onto the traditional product line: promising artificially high results, projecting grandiose outcomes based on unrealistic assumptions and, worst of all, seeking higher returns by ignoring the classic risk/return theory and loading portfolios with high-yield junk to support the yields necessary to keep those promises.
Predictably, many insurers failed or were damaged badly by the effort. But many continue to follow the same map into the new millenium.
But the next time we marshall our forces to enter the investment game, we may find an absolutely stunning welcome, as our financial services competitors embrace us. As we rejoice in the great level field of investment parity, some 535 congressional referees from D.C. will blow their whistles and announce a new rule: No more MECs. And no more tax exemptions for death benefits or deferrals for annuities. From that point on, insurance would equal investment, and everything would be taxable--regardless of where or how it was earned.
Let us get our feet back on the ground: If we create and sell insurance, we need not fear legislative or theoretical setbacks. Going back to our roots may have considerable merit, both sociologically and psychologically, and it might even ensure the success of the industry or protect it from the plunderers of the Potomac. Protection is not such a bad idea, after all-- at least for the insurance business.
The only way to ensure profitability would be to price the policy at advanced ages with a zero lapse rate. Few, if any, companies do this because premiums for policies priced at zero lapses would be as much as 50% higher than those for policies priced with a 5% lapse rate. Moreover, a plan priced at zero lapses would be non par whole life, not private placement, and it would offer non forfeiture values equal to the asset shares at no extra cost.
So why do companies offer lapse-supported prices on private placement life insurance at advanced ages? According to one of several theories, it is possible to use the average lapse rate for all ages combined rather than age-specific lapse rates. However, this technique is inappropriate because lapse rates are much lower at higher ages, which should be reflected in the pricing. By using a cross-subsidy (by age) of lapse rates, one runs the risk of overselling at the "wrong" ages and underselling at the "good" ages. This would more likely occur in a company that uses average lapse rates than in a company that uses age-specific lapse rates for pricing.
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