Implications of the End of Level Premium Period
November  2012

​​​​​​​​Every day hundreds of term life policyholders receive 60-day notices of rate changes because their level premium guarantee is coming to an end. And the premium jumps can be jaw dropping – often 5 to 10 times the rate paid during the level period. In response, most policyholders lapse their contract when the level premium period ends or within a few months thereafter – the shock lapse. Although product actuaries assumed this would happen when they began developing these products more than a decade ago, there was no real experience available at the time to guide their expectations.

With term life insurance sales flat or declining, companies are looking for other ways to generate or retain revenue streams. One area being explored is the end of level period (EOLP) pricing on inforce term blocks that will soon be entering the post-level term period. By altering its EOLP premium scales, an insurer may be able to retain some business for a few extra years and extract additional earnings out of an inforce term block. The challenge is finding the premium rate sweet spot, where enough healthy lives persist to cover the additional claims that will be incurred.

Mortality, Lapse and Consumer Behavior

Life insurers have accumulated abundant lapse data, and mortality experience is emerging for policies in the early EOLP durations. Where companies have less expertise, however, is in clearly understanding the correlation between mortality, lapse and consumer behavior. The industry is working hard to increase its understanding of these interactions as more experience data emerges.

When these term products were originally priced, the focus was on the projected results over the level term period. Less focus was put on maximizing the results in the post-level term period. Generally the starting point was to set the guaranteed EOLP rates as a multiple of the valuation mortality rates to avoid deficiency reserve issues in the post-level period. Then, if a non-guaranteed EOLP scale was a desired product feature, the non-guaranteed rates were typically set conservatively to cover expected anti-selection, often some percentage of the guaranteed scale.

This EOLP premium scale approach results in high EOLP premium jumps, with high EOLP lapse rates and correspondingly high anti-selective mortality following. With very little experience data to rely on, EOLP shock lapse assumptions were typically set in the range of 70-90 percent. As actual experience has emerged, many companies are finding that their shock lapses are significantly higher than originally expected, resulting in decreased revenue streams. In addition, higher lapse rates usually bring higher anti-selective mortality and ultimately reduced profits.

Today, carriers – in conjunction with their reinsurers – are exploring adjustments in their EOLP premium rate scales to curb the high EOLP lapses and perhaps preserve some of the waning profitability they are seeing on their inforce term blocks. The challenge in adjusting rates to achieve these objectives is in determining how to set rates sufficiently to reflect the actual risk underwritten but keep them low enough to encourage relatively healthy mortality risks to persist. This balance requires modeling consumer reaction to more moderate premium jumps that grade in gradually (3-4 years) versus a much larger one-year shock rate.

However, many carriers have little or no EOLP lapse and mortality experience data that reflect the impact of a more gradual premium jump approach. An obvious alternative is to look towards industry data, such as the 2010 SOA Report on the Lapse and Mortality Experience of Post-Level Premium Period Term Plans or to their reinsurers’ experience, as a starting place to set revised assumptions.

As always when using industry data, carriers will want to look at a range of scenarios, as individual company results likely will vary from the aggregate industry results for a variety of reasons.

Firms that have used the most conservative EOLP rate scales (effectively encouraging very high lapses) may want to assess the impact of introducing less severe initial rate increases, grading over several years to a more typical ultimate scale. This change could result in initial EOLP rate increases dropping by roughly 65 percent (for example, from seven times the level premium to three times). While decreasing premium rates may seem to be counterproductive to the goal of increasing revenue, the lower rates should encourage more lives to persist and, if set appropriately, therefore could actually increase overall revenue on the block.


The Effects of Rate Jumps to Shock Lapse

SCOR has been examining EOLP rate structures and its impacts on various companies’ shock lapse and mortality experience in detail for some time now. Figure 1 illustrates an industry estimate of the lapse differential at various EOLP premium jumps. As can be seen from the table, introducing a rate increase of seven-plus times the level premium can result in an 82 percent initial shock lapse.

In contrast, a rate increase of three times or less may reduce the initial shock lapse almost by half. However, in addition to the initial shock lapse at the EOLP, there is often a second although less severe shock lapse in the duration immediately following the EOLP, which we will explore later.

Figure 1 – Differences in Shock Lapse Effects by Rate Jump Multiples
Premium Jump Ratio BandEOLP Shock Lapse
1.01x - 2x43%
2.01x - 3x45%
3.01x - 4x51%
4.01x - 5x64%
5.01x - 6x74%
6.01x - 7x82%
7.01x - 8x84%
8.01x - 10x81%
10.01x +89%

Industry data indicate  that incorporating a smaller jump many encourage stronger persistency. (Source: SOA Report on the Lapse and Mortality Experience of Post-Level Premium Term Plans, July 2010)

But a lower lapse rate is only helpful if accompanied by improved mortality. The SOA report data in Figure 2 illustrates the effects that lower rate increases may have on expected residual mortality. The mortality experience associated with an EOLP premium jump of three is roughly 65% of the experience for an EOLP jump of seven.

Figure 2 – The Relationship between EOLP Rate Increases and Residual Mortality
 Actual / Tabular Mortality
Premium Jump Ratio Band08 VBT01 VBTSOA 7580vs LP
1.01x - 2x168%114%79%148%
2.01x - 3x201%137%112%180%
3.01x - 4x175%116%87%137%
4.01x - 5x190%126%89%165%
5.01x - 6x298%195%142%282%
6.01x - 7x325%216%167%321%
7.01x - 8x343%243%195%349%
8.01x +316%206%157%323%

Pricing strategy can be very influential  on how many lives persist following the EOLP and the mortality pattern that results. (Source: SOA Report on the Lapse and Mortality Experience of Post-Level Premium Term Plans, July 2010 )

Revenue Analysis – A Win-Win Proposition

Both direct writers and their reinsurers should have an interest in analyzing the revenue impacts of alternative EOLP premium scales. Certainly higher premium revenue could be argument enough, if the increased premium income more than compensates for possible increased claims and expenses. Additionally, carriers may earn reinsurance allowances on inforce business. By inducing greater retention exhibiting improved mortality, a company can increase both the actual retained net premium income as well as a significant boost in coinsurance allowance revenue.

To demonstrate potential revenue impacts of lowering the initial EOLP premium scale, we projected cash flows on a representative block of 10-year level term policies entering the ELOP under various assumption sets for five years past the level period (Figure 3).

Figure 3 – Direct Writer View before Reinsurance
ScenarioAvg EOLP
Jump Ratio
Avg Assumed Lapse %
at the end of Dur 10
Avg Assumed Lapse % Dur 11Avg Assumed Mortality Deterioration Dur 11PV of Premiums (millions)PV of Claims (millions)PV of Allowances (millions)PV of Net Cash flows (millions) 
16.480%15%275%26.118.6NA7.5
26.473%45%298%19.715.0NA4.7
32.549%45%171%26.519.2NA7.2
42.557%45%228%22.821.0NA1.8


Scenario 1 represents the original EOLP premium rate scale and the EOLP mortality and lapse assumptions used in the original pricing. The original premium scale represents a relatively high average initial EOLP premium jump ratio of just over six, followed by 10-percent annual increases. The original pricing assumed an 80-percent shock lapse at the end of the level premium period, followed by subsequent 15-percent annual lapses. A Dukes-MacDonald model was then used to project the mortality deterioration associated with this pattern of lapses.

Scenario 2 represents the original EOLP premium rate scale and the impact of revised assumptions consistent with the aggregate-industry EOLP shock lapse and mortality experience data.

Scenario 3 represents the impact of lowering the initial EOLP premium scale to an average EOLP initial premium jump ratio of 2.5 (grading over three years to a typical ultimate scale) and assumption revisions based on the industry EOLP shock lapse and mortality data.

Scenario 4 represents the impact of lowering the initial EOLP premium scale to an average EOLP premium jump ratio of 2.5 and an assumption sensitivity based on a 1 “bucket shift” to the industry EOLP shock lapse and mortality data – for example, utilizing the higher lapse and mortality data associated with a premium jump ratio of four instead of three.

It is important to note that in addition to the initial EOLP shock lapse at the end of duration 10, actual experience indicates a second significant shock lapse occurring in duration 11. In addition, the experience data suggests this additional shock lapse is highly skewed to the early months in duration 11. Therefore, any cash flow projections should consider the impact of this additional shock lapse and the associated skewed pattern.

First we will look at net cash flow projections from the direct writer’s point of view (Figure 3). Projected premiums are exclusive of the annual policy fees, which are assumed to cover ongoing maintenance expenses. The Scenario 2 projections indicate that projected cash flow could be reduced by roughly 40 percent, versus original expectations, if actual lapse and mortality experience is consistent with the industry data.

By lowering the EOLP premium scale to an average initial jump ratio of 2.5, most of the lost revenue may be restored assuming that EOLP lapse and mortality experience will be consistent with the industry experience associated with these lower premium jumps. However, the sensitivity test in Scenario 4 shows an additional decrease in revenues if mortality and lapses actually emerge worse than industry experience.

After Reinsurance

As a significant portion of the term business written in the early 2000s was reinsured, often as much as 90 percent of given portfolio, it is important to analyze the impacts on an after-reinsurance basis. In addition, as the impacts may vary significantly between the direct writer and the reinsurer, it is important to consultant with your reinsurance partner(s) on any EOLP premium scale change to ensure interests are aligned.

Figure 4 projects the same four scenarios with adjustments to reflect a 90-percent coinsurance arrangement with an average renewal allowance of 15 percent. Both Scenarios 3 and 4 show an increase in net revenues with a lower initial EOLP premium scale.

Figure 4 – Direct Writer View after Reinsurance (90% Coinsurance with 20% allowance)
ScenarioAvg EOLP
Jump Ratio
Avg Assumed Lapse %
at the end of Dur 10
Avg Assumed Lapse % Dur 11Avg Assumed Mortality Deterioration Dur 11PV of Premiums (millions)PV of Claims (millions)PV of Allowances (millions)PV of Net Cash flows (millions)
16.480%15%275%2.61.93.54.3
26.473%45%298%2.01.52.73.1
32.549%45%171%2.61.93.64.3
42.557%45%228%2.32.13.13.3

Under a 90/10 coinsurance agreement, a reduction in the initial EOLP premium jump may create significant recovery to potential lost revenues.

However, when we look at these scenarios from the reinsurer’s viewpoint, Scenario 3 shows a significant increase in revenues whereas Scenario 4 shows a significant decrease (Figure 5). These results demonstrate the importance of working with your reinsurance partner(s) early on in any redesign of an EOLP premium scale to ensure a consistent view in assumptions and equity in the projected impacts.

Figure 5 – Reinsurer View (90% Coinsurance with 20% Allowance)
ScenarioAvg EOLP
Jump Ratio
Avg Assumed Lapse %
at the end of Dur 10
Avg Assumed Lapse % Dur 11Avg Assumed Mortality Deterioration Dur 11PV of Premiums (millions)PV of Claims (millions)PV of Allowances (millions)PV of Net Cash flows (millions)
16.480%15%275%23.516.73.53.2
26.473%45%298%17.713.52.71.5
32.549%45%171%23.817.33.62.9
42.557%45%228%20.518.93.1-1.4

Projected impacts from the reinsurer's perspective may not always align with those of the direct writer.

Conclusion

Life insurers are entering a period of potential EOLP premium scale repricing that was perhaps anticipated but whose ramifications were not fully considered, especially in the context of today’s challenging market. Given the magnitude of the industry’s exposure – by number of policies approaching the EOLP, their cumulative face amount and premium – companies are rethinking their approaches to this re-pricing opportunity.

Based on SCOR’s research, companies maybe able to gain a significant increase in revenues through a redesigned EOLP premium rate strategy. As a major term life reinsurer, SCOR welcomes the opportunity to work with our clients to develop win-win strategies for optimizing post-level period revenues.