Accelerated Death Benefit Rider Financing Approaches
By Stephanie Scholz and Robert Eaton
Product Matters!, June 2022
Introduction
Living benefit riders to life insurance policies (also known as ‘combo’ or ‘hybrid’ policies) have become a core component of life insurance sales strategy. LIMRA reported that in 2020 “Combination products represented 24 percent of life insurance sales based on total premium.”[1] Concurrently, the long-term care insurance (LTCI) industry reached an inflection point when more LTCI (and chronic illness) benefits were sold through hybrid products than from standalone LTCI coverage.
On the spectrum of life and LTCI hybrid policies, the richest of these provide coverage of LTCI first through accelerating the policy’s death benefit, and then by providing extended LTCI benefits for many more years. There are a handful of individual and worksite insurers who sell these rich hybrid policies. On the other end of this spectrum are acceleration-only riders to life insurance policies. These riders provide policyholders the opportunity to receive a portion of the policy’s death benefit in advance, under certain conditions. Some of these riders do not cover qualified LTCI, but instead cover ‘chronic illness,’ which has a similar benefit trigger but is not formally LTCI.
This article outlines industry practice and consideration for pricing these acceleration-only policies. The National Association of Insurance Commissioners (NAIC) Model Regulation #620 addresses accelerated death benefit riders to life insurance policies.[2] Model Regulation #620 outlines three financing methods for accelerated death benefit riders which we describe in this article. The Interstate Insurance Product Regulation Commission (the IIPRC, or the “Compact”) adopted standards for some of these riders in the Additional Standards for Accelerated Death Benefits (IIPRC-L-08-LB-I-AD-3).[3] For companies filing chronic illness, critical illness, and terminal illness products in the Compact, these standards define—among other items—the form and actuarial submission requirements and benefit design options for accelerated death benefit riders. If a company is filing an acceleration rider for a qualified LTCI benefit, that product would be subject to the IIPRC individual LTC insurance standards.
NAIC Model Regulation
The NAIC Model Regulation #620 describes the actuarial standards for accelerated death benefit riders, including describing the impact of the accelerated death benefit on cash value and policy loans, and how companies may finance the benefit. While most insurance products are financed by the customer who pays premiums or cost of insurance (COI) charges, a company may assess a charge for accelerated death benefit riders through different financing methods.
Financing Method 1: Premium and Charges Assessed to Provide Dollar-for-Dollar Benefits
This method is straightforward: the company charges explicit premiums or COIs to fund the option to accelerate the life insurance benefit. If the policyholder is eligible to accelerate the death benefit for a chronic illness or long-term care event, the policyholder may elect to receive a portion (sometimes up to the full amount) of the death benefit in advance. The policyholder will receive the benefit dollar-for-dollar.
Dollar-for-Dollar Financing Example
- Base life insurance chassis: whole life with $1M death benefit
- Accelerated death benefit rider premium (explicit cost to the customer): 6 percent of the base policy level premium
- Benefit payment: that policyholder chooses to accelerate 20 percent of the face amount of their policy, or $200,000. This may be provided as a lump sum or in periodic installments. In this case, the entire $200,000 accelerated benefit is paid to the policyholder[4] and $800,000 of the life insurance death benefit remains.
- Reduction in accelerated benefit amount (implicit cost to the customer): None
- Reduction in death benefit amount: $200,000
We observe in practice that a company determines the premium or charges for the dollar-for-dollar acceleration benefit using one or more of the following methods:
- Loss Ratio
- IRR
- Other company profit metrics
Insurers today commonly calculate the premium or charges for this benefit within the same model they use to calculate the premiums (COIs) of the underlying life insurance policy.
These models will rely on the actuary’s assumptions around the acceleration benefit, primarily claim incidence and post-claim mortality. Today’s best practice applies assumptions for the accelerated benefit to the projections from the base life insurance policy to produce cash flows of the combined base and rider. The combined base and rider cash flows are then used to determine the premium (COI) that produces the same profit metric as the base policy on its own. The pricing actuary may bifurcate the total mortality assumption, and apply a separate active life mortality assumption to the projected population who do not trigger the acceleration benefit. In this case, the actuary can balance the mortality of the cohorts to a total mortality assumption (see this paper[5] for a more detailed discussion of the conservation of mortality).
Other modeling approaches may calculate the rider premium (COI) in a separate model from that of the base life insurance chassis. Without the combined base and rider cash flows, the actuary will make simplifying assumptions as to the impact of the rider on the base policy, such as for the conservation of mortality.
Financing Method 2: Actuarial Present Value
Under the actuarial present value method of financing, part of the cost of the rider is assessed as a reduction to the benefit paid. These riders do not typically charge an explicit premium (though this is not prohibited), but instead the rider benefit payment is reduced before it is paid to the policyholder. We reviewed the actuarial memoranda for over 40 different companies who have filed accelerated death benefit riders that are financed using the actuarial present value method. We observe in practice that companies financing riders using this method follow one of two general approaches below.
Approach A: Benefit Payment Reduction Calculated At the Time of Claim
This is the most common approach among the filings we reviewed. In this approach, the policyholder elects an amount of death benefit to accelerate. The company then reduces the actual benefit payment by an amount that accounts for the net loss in cash flows, should the policyholder not have elected the acceleration. This reduction amount is most commonly determined using actuarial assumptions (such as mortality, persistency and interest) and a present value accounting at the time of claim, comparing the net cash flows with and without the death benefit acceleration. Some companies with participating products incorporate the present value of future dividends as well. Importantly, these assumptions may change between the time the customer purchases the rider and the time the customer requests the accelerated benefit, and therefore the benefit payment reduction cannot be known at the time of purchase.
A number of companies determine the present value using an explicit life expectancy calculation, which may vary by the condition of the policyholder. This life expectancy— calculated at the time of the claim—is used to determine the benefit payment reduction to apply to the death benefit requested.
Actuarial Present Value Financing Example—Approach A
- Base life insurance chassis: whole life with $1M death benefit
- Accelerated death benefit rider premium (explicit cost to the customer): No up-front or explicit charge for the rider
- Benefit payment: The policyholder chooses to accelerate 20 percent of the face amount of their policy, or $200,000. This may be provided as a lump sum or in periodic installments. At the time of claim the company calculates the net present value of cash flows under the scenario where the policy accelerates the death benefit and compares that to the same calculation assuming the policyholder does not. The company determines that it is forgoing 30 percent of its net cash flows if the policyholder accelerates the death benefit, and they offer the policyholder a 30 percent reduction in the accelerated amount, or $140,000.
- Reduction in accelerated benefit amount (implicit cost to the customer): $60,000
- Reduction in death benefit amount: $200,000
Approach B: Benefit Payment Reduction Determined At the Time of Sale
Under this approach the accelerated benefit payment reduction for all policies is determined at the time the policy is issued. The payment reduction is calculated using actuarial assumptions as of the time of the policy issue, and does not change throughout the life of the policy. These reductions may be flat across all policies (e.g., a 20 percent reduction) or may vary by attained age, sex or other demographics.
The method for calculating this benefit payment reduction uses a present value approach, and the reduction can be calculated to equate the profitability of the base policy with that of the base policy plus rider.
Actuarial Present Value Financing Example—Approach B
- Base life insurance chassis: whole life with $1M death benefit
- Accelerated death benefit rider premium (explicit cost to the customer): No up-front or explicit charge for the rider
- Benefit payment: The policyholder chooses to accelerate 20 percent of the face amount of their policy, or $200,000. The company determined at time of issue—and stated in the acceleration rider— that they would assess a 20 percent reduction in the payment of benefits to account for the company’s cost of accelerating the death benefit. In this case, a $160,000 accelerated benefit is paid to the policyholder, and $800,000 of the life insurance death benefit remains.
- Reduction in accelerated benefit amount (implicit cost to the customer): $40,000
- Reduction in death benefit amount: $200,000
Company Risk Considerations under Approach A and Approach B
Under Approach A, the company mitigates its risk related to assuming incidence rates, since only the customers who make a claim will pay the implicit cost. The company also mitigates assumption misestimation risk related to timing, since the actuarial present value benefit reduction is determined in the future at the time of claim. The only substantial actuarial risk the company takes under Approach A is estimating the policyholder’s mortality and future cash flows at the time of claim.
Under Approach A the company does assume some reputational risk. The policyholder cannot know in advance what the benefit payment of the accelerated death benefit rider will be, though the premium charged is typically $0. This type of accelerated death benefit sale, for LTCI or chronic illness, has led to customer confusion at the time of claim payment, and in some cases legal action against insurers. Among filings we reviewed, this was the most common actuarial present value approach used by companies (93 percent vs. 7 percent for Approach B).
Under Approach B, because the company is determining the benefit reduction at the time the policy is filed with a regulator, the company accepts the routine pricing risks of estimating future mortality and cash flows at the time of sale. The policyholder under Approach B has the advantage and comfort of knowing in advance their benefit payment under certain scenarios.
Financing Method 3: Policy Liens
The third option that a company may use to finance an accelerated death benefit is to charge interest on the amounts accelerated. The NAIC Model Regulation stipulates a maximum interest rate that may be used, which is a rate no greater than the greater of:
- The current yield on 90-day treasury bill; or
- The current maximum statutory adjustable policy loan interest rate.
The IIPRC further specifies for its standards that the policy loan interest rate is that which is permitted under NAIC Model #590.
Policy Lien Financing Example
- Base life insurance chassis: whole life with $1M death benefit
- Accelerated death benefit rider premium: No up-front or explicit charge for the rider
- Benefit payment: The policyholder chooses to accelerate 20 percent of the face amount of their policy, or $200,000. This may be provided as a lump sum or in periodic installments. In this case, the entire $200,000 accelerated benefit is paid to the policyholder.[6] The remaining life insurance death benefit is $800,000, and a $200,000 policy loan is established. In the years following the claim, if the policy loan is not repaid, the loan grows with interest and the death benefit is further reduced.
- Reduction in accelerated benefit amount (implicit cost to the customer): $0
- Reduction in death benefit: $200,000 initially, which can be further reduced by interest accumulating on the policy lien
IIPRC Standards
The latest revision to the Additional Standards for Accelerated Death Benefits was adopted by the IIPRC on Aug. 15, 2014. The Standards outline the requirements for filing accelerated benefit products with the Compact.
Benefit Design Options
The IIPRC does not explicitly state the same three financing options as the NAIC Model Regulation. Section §3.B. (Benefit Design Options) of the Standard provides requirements for accelerated death benefits that allow for the present value calculation (§3.B.(2)) and for those riders that treat the acceleration as a lien the death benefits of the policy ( §3.B.(3)). The Standard does not explicitly address a dollar-for-dollar financing method funded by an explicit premium. Without specific guidance on this NAIC method, as an alternative some companies have filed an accelerated death benefit rider with the IIPRC using the lien financing approach, and charging 0 percent interest on the lien. Companies taking this approach are able to charge an additional premium or COI for the benefit. An acceleration rider filed with the IIPRC must provide for an acceleration upon terminal illness in addition to providing an acceleration for other qualifying events. The IIPRC requires that there be no charge for the terminal illness acceleration rider, so some companies elect to file the terminal illness acceleration benefit separately from other acceleration riders. There can be certain pricing advantages to a policyholder having many acceleration riders drawing from the same pool of benefits, as described in the Product Matters! article “Living Benefit Riders to Life Insurance Policies: Pricing Considerations and Strategy.”[7]
Incidental Value
Section §1.B(1)(i) of the Standards states that for a chronic illness, confinement, or critical illness accelerated death benefit, the actuary must provide “a certification that the value and premium of the accelerated death benefit is incidental to the life coverage.” Appendix A of the IIPRC Standard provides an actuarial certification template that requires the actuary to certify that:
- The actuarial value of the benefits provided in the rider is not greater than 10 percent of the actuarial value of the benefits of the base policy. This determination is to be calculated across “a range of underwriting classes and plans” and using a 6 percent discount rate.
- The separate premium or cost of insurance (COI) for the rider, over the life of the policy, should not exceed 10 percent of the premium or COI for the policy absent the rider.
This test ensures that the accelerated death benefit rider (both premiums and benefits) is relatively minor compared to the base life insurance contract.
Other Jurisdiction Variations
Some other states and jurisdictions offer variations on the NAIC model regulation and the IIPRC standards. Certain states require that a lump sum option be made available, and other states specify particular different benefit triggers that must be made available.
The actuary should carefully read the accelerated death benefit regulations of any state, prior to their filing process.
Conclusion
While acceleration only riders are the simplest form of living benefit riders, they play an important role in the life insurance industry, attracting policyholders with a low-cost and flexible benefit. Actuaries will make financing and benefit design decisions for acceleration products that have meaningful implications for consumers. Financing and designing these riders in a consumer friendly manner can make way for companies to provide more LTCI coverage for the oncoming wave of retirees who face LTC needs.
Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries, the editors, or the respective authors’ employers.
Stephanie Scholz is an actuarial analyst at Milliman. She can be reached at stephanie.scholz@milliman.com.
Robert Eaton, FSA, MAAA, is a principal and consulting actuary at Milliman. He can be reached at robert.eaton@milliman.com and on twitter @loveactuary.