Universal Life No-Lapse Guarantee Reserve Strain
A mid-sized mutual life insurer carries 12,400 universal life policies with no-lapse secondary guarantees. Aggregate face amount is $2.2 billion, account value is $390 million, and the AG 38 reserve is $1.52 billion. Forty-two percent of policies have shadow-account deficits totaling $180 million; these policies have paid only minimum premiums for six years. The current portfolio earned yield is 4.5%, the crediting rate is 4.2%, mortality is running at 88% of pricing, and lapse experience is 4.2% versus 6.0% priced. Lower lapses have kept more guaranteed benefits in force, and the chief actuary believes reserves are understated. Company surplus is $1.0 billion and the RBC ratio is 365% against a 350% internal target. The board wants to pay a $60 million dividend to the parent mutual holding company and launch a new guaranteed UL product with the same design. The CFO asks for a finance and capital assessment before the next board meeting.
1. Estimate the direction and rough magnitude of the statutory reserve change from the current mortality and lapse experience, and explain how that change affects surplus and RBC. State any assumptions.
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Reserve per policy is $1.52bn / 12,400 ≈ $122,600. A 1.8-point lapse shortfall means roughly 12,400 × 1.8% ≈ 223 policies remain that were expected to leave; at the average reserve that is about $27m, and because underfunded policies carry above-average reserves, a reasonable range is $30m-$45m. Mortality at 88% of pricing is favorable, but the effect on no-lapse reserves is not one-for-one: lower cost-of-insurance charges slow shadow-account depletion, which reduces reserves, while more survivors reach high-cost ages, which increases them. A cash-flow projection is required; a plausible net reserve increase is $20m-$60m. Against $1.0bn surplus, a $50m strengthening cuts surplus to $950m. Required capital is approximately $1.0bn / 3.65 ≈ $274m, so the RBC ratio falls to about 950/274 ≈ 347%, below the 350% target. The $60m dividend would take surplus to $890m and RBC to roughly 325%, so it is not supportable without new capital or risk transfer.
2. Recommend whether to pay the dividend, and outline two capital or product actions that address the block without harming policyholder reasonable expectations.
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Do not pay the $60m dividend. The reserve sensitivity alone consumes most or all of the proposed distribution, and RBC is already close to the internal target before any strengthening. Paying it would leave the company with less than one year of cushion against adverse mortality or lapse experience and would weaken the rating-agency conversation.
Two actions are preferable. First, retain the $60m and establish an explicit reserve-strengthening provision, with quarterly monitoring of shadow-account deficits. Second, offer targeted policyholders a voluntary funding increase or exchange to a better-funded design, without changing contractual guarantees. For new business, reprice the guaranteed UL design: raise minimum premium requirements, shorten the guarantee period, or add a secondary-guarantee charge. If the block remains capital-intensive, seek a reinsurance solution for the tail risk. These actions protect policyholder reasonable expectations because existing guarantees are honored; they change only non-guaranteed elements and new-business terms, with documented support.