Covid-19’s impact on the charge assumptions for unit-linked business

Meeting

A group of Life actuaries, working as part of the IFoA Covid-19 Action Taskforce (ICAT) have been considering various ways that the pandemic has affected Life insurers. 

This blog discusses Covid-19’s impact on considerations for setting assumptions for unit-linked business charges. 

Introduction
The Covid-19 pandemic has had an impact on various parts of life insurance operations, including the assumption setting process. This brief note aims to consider the potential impact of the pandemic on setting up the future charge assumptions for unit-linked products, including pricing assumptions for new business and valuation assumptions for existing business (where charges are reviewable).

Considerations
The following are the key areas of consideration for setting up the charges for unit-linked/investment-linked products:

1.  Premium Allocation charges

These charges are of fixed nature and are deducted as a fixed percentage of the premium received. They are levied to cover the initial & renewal expenses and are usually based on the assumption of expected future new business. 

  • As the pandemic may impact the growth of future new business, insurers should revisit the initial expense assumptions and hence the allocation charges. Insurers need to consider the impact on the expected future new business, say, Annualised premium equivalents (APE) measure, based on the emerging experience as future new business volumes may change. 
  • Impact of lapse/paid-up rates and changes to these on the non-lapse supported products (i.e. products with no surrender charges) need to be considered, and hence assumptions of initial or renewal expenses. (If actual lapses are more than expected then per policy or other expense assumptions need to be revisited)
  • Consider the inflation rate assumption and its impact on this charge. Inflation rates may increase in the short-term which will impact the estimate of renewal expenses and potentially this charge. 
  • Given the current economic environment, insurers might be capital strained. They may want to have a high charge initially in the form of high allocation charges to meet the initial expenses/new business strain for the front-loaded products where these still exist.

2.  Mortality charges
These charges are taken to provide life cover in excess of the value of units. These charges vary with age and are deducted monthly.

  • Consider whether the company has sufficiently credible data or has otherwise justified decisions for changes in mortality rates. If mortality rates increase due to Covid-19’s impact, insurers may decide to review mortality charge assumptions. This will need to be based on the emerging experience bearing in mind product terms and conditions in place.
  • Since the pandemic’s impact on mortality rates is higher for the older population it may not affect the mortality charge assumptions for all unit-linked products as some of these products are more popular among the younger population. For example, unit-linked pension products are taken by older individuals and investment-linked products are generally taken by younger groups of people. Insurers may change the maximum ages to offer plans if mortality risk is more significant.
  • Since these charges are levied on the sum at risk (where there is guaranteed death benefit) i.e. the difference between the sum assured and fund value, insurers need to consider the impact of falling fund values on the mortality charges, as this may lead to a biting scenario. For example, if the sum at risk increases more than expected then this may impact the charges and hence the income to the insurer. For example, if the market falls steeply as it did in March 2020, depending upon how the funds are invested, fund value can even be negative. If the market rebounds, however, the fund value can increase and the sum at risk will reduce again.
  • For setting up the valuation assumption for existing business, insurers might need to perform sensitivity/scenario testing around mortality and fund values to estimate how much potential extra capital they may need to hold.

3.  Fund Management charges
Insurers earn fees as a fixed or variable percentage charge of the fund value. It is levied for management of the various funds. 

  • Consider the impact of a reduction in fund values on unit-linked or investment-linked products that are directly affected by market fall. The impact of lower asset values leads to a proportionate reduction in the fee income to the insurers. Hence insurers are required to revisit the fund management charge assumption based on the revised fund values or revised future assumptions of fund growth rates.
  • Insurers should also consider the impact of an increase in lapse/paid-up rates on investment-linked funds. Such policyholder behaviour needs to be considered while setting up the assumption of fund management charges as this may lead to loss of future charges/fees income to the insurers (especially for products that do not have surrender charges).

4.  Policy administration charges
This is the fee levied by insurers for policy administration purposes. It may or may not be linked to inflation.

  • An insurer's expenses may increase due to an increase in inflation rates. These charges need to be revised if not linked to inflation. 
  • These charges are generally levied as a fixed percentage of the fund value or by cancellation of units from the fund. Hence, the impact of falling fund values on the fixed percentage assumption may need to be revisited.

5.  Others 

a.  Investment guarantees charges
Some investment-linked products provide guarantees to the policyholders, for example, a guaranteed minimum maturity benefit (GMB), guaranteed minimum surrender value (GSV), and others. Insurers generally charge a cost for these types of guarantees by deducting separate charges for each guarantee or by increasing other charges like Fund Management Charge (FMC) or allocation charge. 

  • For valuation of existing business, guarantees and their respective charges need to be separately considered as more capital may need to be held by insurers in this respect.
  • The impact of a reduction in asset or fund values for unit-linked or investment-linked products needs to be considered by insurers. For example, a reduction in fund values may create a biting scenario for insurers under these types of guarantees.
  • Charges for these types of guarantees will not be sufficient (where backing assets /value of funds are insufficient to meet the guarantees) and need to be revised based on the current scenario and changes in the future expected returns.
  • Insurers may also need to consider the impact of falling fund values on guaranteed annuity option charges for unit-linked pension products.

b.   Rider charges
Rider charges are deducted from the policyholder funds based on the rider attached to each policy.

  • Insurers need to consider the impact on these costs especially for a health benefit or hospitalisation benefit riders. Insurers need to revisit the assumption of rider charges based on emerging experience or may put additional margins over and above the base assumptions from a prudence perspective.

Summary
The pandemic has its potential impacts on setting future charge assumptions for unit-linked products for both new and existing business. Insurers may need to revisit all these assumptions in the light of additional considerations due to Covid-19.

The combined impact of an increase in charges on persistency and future new business need to be considered. For example, an increase in premium allocation charge may impact the growth of future new business and insurers may instead want to consider increasing surrender charges (if applicable). Insurers may also need to factor in their competitors’ behaviour in this respect and how proposed changes will be communicated to policyholders where relevant.

The impact of factors like a potential increase in sales of unit-linked products should not be overlooked as the percentage of people who are willing to invest in risky assets might increase. This may lead to new business capital strain on insurers’ balance sheets.

*The members are Anjali Mittal, Burcin Arkut, Isha Aggarwal, Isha Kulkarni, Jagrit Bagga, James Gillespie, Justine Morrissey, Mcebisi Dhlamini, Nainjeet Juneja, Natalia Mirin (Workstream Lead), Roy Perlson, Sanjoli Choudhary and Thomas Treacy.