Life Insurance Customers Push Back Over Surprise Cost Increases
September 1, 2016 by Leslie Scism
Americans are starting to fight back against a wave of insurance-price increases on decades-old life policies.
Over the past year, several major insurers have notified tens of thousands of people of higher costs to keep their policies in force, with increases ranging from midsingle-digit percentages to more than 200%, according to financial advisers. To justify the increases, they blamed the impact on their investments from the Federal Reserve’s decision to keep interest rates lower for longer.
At least a half-dozen lawsuits have been filed in federal courts against insurers including Aegon NV’s Transamerica unit and Legal & General Group PLC’s Banner Life.
In many of the suits, which seek class-action status and damages, the plaintiffs contend insurance firms are hiding behind little-used contract provisions to rummage up cash for shareholder dividends. They also argue that increased lifespans have offset the negative impact on profits of lower bond yields.
The insurers counter that these cost increases are permitted under provisions that allow them to charge up to a maximum amount, based on expectations of future policy performance. The insurers claim those expectations have plummeted with the Fed keeping short-term interest rates at near zero for nearly eight consecutive years.
Fed Chairwoman Janet Yellen signaled last week that the central bank could possibly start to raise rates this month, but many analysts don’t see rates increasing meaningfully enough soon to change the situation for insurers.
“Companies are under a lot of pressure to boost returns in this low-interest-rate environment, and this is one lever they have,” said Scott Robinson, an associate managing director at Moody’s Investors Service. “Companies have to weigh the right they may have versus what impact it might have on their reputation in the marketplace with the various parties.”
Among upset policyholders is Raymond Foos, an 87-year-old retired manufacturing chief executive who purchased an $11 million policy in 2003 to benefit his children. This spring, Transamerica informed him of an increase that he said will cost him nearly $300,000 a year, on top of the $2.25 million he paid as a lump sum to buy the policy and which he thought would cover costs through his and his wife’s death.
Mr. Foos, who said he is exploring legal action, regrets not asking enough questions about risks when he bought the policy.
He said Transamerica should “bite the bullet.” Drawing from his years of running a business, he said, “when you have a sale that you lose money on, you don’t go to the customer and say, ‘Give me some more money.’ You generally figure out how to live with your problem and go on….You tighten your belt.”
Speaking generally, a Transamerica spokesman said the insurer’s increases leave costs “at or below the maximum rates allowable” by contract.
Life insurers have been among the companies hardest hit by the Fed’s policies, which have been mirrored by many central banks around the world. These firms earn much of their profit by investing customers’ premiums in bonds until claims come due. Shares of big U.S. life insurers have dropped 5.4% since the start of 2008 through Wednesday, according to the S&P Composite 1500 Life & Health Insurance Index, compared with a 48% gain for the S&P 500.
At issue are “universal life” policies. In short, the policies combine a death benefit with a tax-advantaged savings account that has a minimum interest rate. Such policies accounted for more than a quarter of all individual life-insurance sales in some years past. Millions of Americans own them.
Insurers’ problem is that many older policies guarantee annual interest rates of 4% to 5%. In the mid-1980s, when universal life policies surged in popularity, the average investment portfolio yield for life insurers was nearly 10%, according to ratings firm A.M. Best Co.
Today, that yield is just under 5%, thanks to a general decline in rates over the decades, followed by the more recent sharp leg down.
In selling universal life, insurers typically aim to earn 1 to 2 percentage points more on the premiums they invest than they pay out in interest to policyholders, said Deloitte Consulting LLP principal Matthew Clark. Most insurers aren’t earning this spread today, and “with continued low rates some could face a situation where they are paying out more to policyholders than their investments earn,” he said.
The lawsuits argue the policies are profitable enough even with shrunken investment yields. They also contend the insurance industry is raising rates to force consumers to cancel policies, thus reducing insurers’ future payouts.
Of the triple-digit-percentage increases, W. Daniel “Dee” Miles, a lawyer suing Banner, said “there is no way they could have missed the mark that bad.”
In court filings, Banner asserts that plaintiffs’ lawyers are using “entirely unrelated legal controversies…to muddy the waters in a relatively straightforward case.”
Also at issue in the lawsuits is “mortality” experience. In setting initial policy charges, actuaries make assumptions about the life expectancy of people who will buy the policies. The lawsuits maintain that the insurers have profited from rising life expectancies across the U.S. population, and that is among reasons they said cost increases shouldn’t be allowed.
In general, if an insurer ends up with customers who live longer than its actuaries anticipated, it can earn bigger profits because it collects more years of premium than anticipated before having to pay death benefits.
Between the investment shortfalls and better-than-expected life expectancies, “the policies are still profitable” on an industrywide basis, said McKinsey & Co. senior partner Giambattista Taglioni. But experience varies across companies. “Some blocks of business are already underwater, and some others have reduced profitability but are still profitable.”
At least two cost-increase cases involving universal life were settled out of court in recent years, said James S. Bainbridge, an attorney who follows litigation for the Association for Advanced Life Underwriting, a lobbying group for insurance professionals.
Write to Leslie Scism at leslie.scism@wsj.com
