Product Development News
December 2005 – Issue 63
Lapse Experience Under
by Dominique LeBel
ompanies in the United States
C have been struggling to develop
best-estimate lapse assumptions
for lapse-supported products, such as
universal life with no-lapse guarantees
and return of premium term, given the
lack of available experience for these prod-
ucts. The financial implications of
over-estimating ultimate lapse rates can
At the same time, rating agencies have
expressed concern about the lapse rates
assumed in pricing lapse-supported prod-
ucts. For example, in its August 2005
report “2005 Credit Issues and Trends for
U.S. Life and Health Insurance,” Moody’s
stated that “Moody’s believes that the
price-competitive fight occurring in the no-
lapse UL market is one of the more
serious long-term credit issues that the
life insurance industry currently faces” in The 1999 study focused on term to 100
part due to the persistency assumptions used products and excluded universal life level
in pricing. cost of insurance products and will be
referred to as the term to 100 study in this
This article provides a review of the avail- article.
able lapse experience for lapse-supported
products. The results of the following three
studies are presented: Universal Life Level Cost of
1) “Lapse Experience Under Lapse- Insurance Products sold in
Supported Policies,” Canadian Institute Canada:
of Actuaries, October 1999. http://www.
a c t u a r i e s. c a / p u b l i c a t i o n s / 1 9 9 9 / Similar to U.S. universal life with no-
lapse guarantee products in that this
product is frequently sold for the
lowest price that will keep the policy in
2) “Lapse Experience Under Universal Life force until the policyholder’s death.
Level Cost of Insurance Policies,” Cost of insurance charges are level
Canadian Institute of Actuaries, June and guaranteed.
/2003/203052e.pdf Term to 100 Products sold in
3) “Long-Term Care Insurance Persistency Guaranteed level premium whole life
Experience,” LIMRA International and products without cash values.
Society of Actuaries, 2004. http://www.
term-care-insurance-persistency-experience/ continued on page 10
Product Matters! 9
Lapse Experience Under Lapse-Supported Products • from page 9
Lapse rates by number of policies and percent for the Canadian studies and from 3
sum insured are presented in Chart 1 below. to 4 percent for the long-term case study.
Ultimate lapse rates range from 1 to 2
10 December 2005
Lapse Experience Under Lapse-Supported Products
Long-term care practitioners generally do study for issue age groups 50 to 59 and 60 to
not use the results of the above long-term 69, where ultimate lapse rates are in the
care lapse study for all issue ages combined range of 1.5 percent to 2.5 percent, which are
(shown in Chart 1) to set ultimate lapse expected to be more indicative of future
assumptions. Instead a more granular experience. The results for these two age
review leads to results more similar to the groups are shown in Chart 2 below.
continued on page 12
Product Matters! 11
Lapse Experience Under Lapse-Supported Products • from page 11
Last survivor (joint second-to-die) lapse required in interpreting the lapse rates in
rates appear to be significantly lower than Charts 2 and 3 where the number of policies
composite lapse rates in the Canadian stud- exposed for these segments is lower.
ies as shown in Chart 3 above, possibly The three studies provide additional infor-
reflecting a more educated sale. mation such as scope, methodology,
The results of these studies indicate that limitations, contributing companies and addi-
the Canadian and U.S. long-term care tional results broken down along multiple
markets are not unsophisticated. Rather criteria. The reader is encouraged to read each
these markets understand the value of the study.
options in lapse-supported products and the The Canadian Institute of Actuaries is
significant internal rates of return that are currently collecting lapse data and will be
foregone upon lapse. It would seem reason- releasing new term to 100 and universal life
able to assume that the U.S. secondary level COI lapse study results in 2006. The
guarantee UL and return of premium term new study will have a larger exposure base
markets also are (or will be) sophisticated and will include later policy durations.
Dominique Lebel, FSA,
and to therefore use the lapse study results Until lapse studies are available for lapse-
FCIA, is a consultant with
as a reference point to set lapse rates. supported products, such as universal life
Towers Perrin in
Adjustments could then be made for product, with no-lapse guarantees and return of
Weatogue, Conn. He can
be reached at Dominique.
distribution and market differences such as premium term, the appropriate level of the
the presence of cash values, commission ultimate lapse assumption to be used for
patterns and the growth of the secondary pricing, cash flow testing, embedded value
settlement market. and GAAP reporting will continue to be
Although it is difficult to ignore the level debated, but actuaries should be aware of
of ultimate lapse rates, it should be noted the available experience, since the financial
that lapse rates may not be statistically cred- impact of overestimating ultimate lapse
ible in later durations. In particular, care is rates can be significant.
12 December 2005