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@ Rex, Thank you for the suggestion and information with respect to learning about Universal Insurance policy. In reading though about this type of policy, though some of the structural elements are similar, other differ from my experience to the product I am familiar with.
a. The product I know overall appears to be very similar to a universal policy. It is permanent insurance, whereby premiums are due/paid quarterly. A person pays the annual premium (1/4 of annual each quarter) associated with their age/health risks per the insurance underwriting, therefore all thing being equal, the premium will rise as a person ages. In this case the premiums for each year are stated upfront for the life of product.
b. You make the most important point about the product; uncertainty of sequential returns (both borrowing costs and investment returns) over the potential life of the product. Especially as it relates to insurance companies that tend to be more risk adverse relative to other asset manager types, partially due to mortality and regulatory requirements. It is also the essence of the premium financing risk; if the returns don’t come to fruition, the policyholder will have to make up the difference in premium relative to the investment return credited to the policyholder. My guess is that a person facing this situation for a year plus will be doing some soul searching to determine if they truly need ‘permanent life insurance’.
c. For the product I know/dealt with, I am unaware of any insurance stated ‘guaranteed returns’. By borrowing/leveraging the amount of invested amount pay future premiums, there are assumptions made with respect to expected returns over time.
d. Where we diverge a bit is around the premium financing aspect of the product. You mention paying quarterly is a bad idea. The product I know didn’t charge an additional finance charge, rather the annual premium was divided into four equal payments without a stated finance charge. If a charge was built into the annual premium itself, that is certainly possible. My guess is the quarterly approach was chosen to match cashflows between the premium and receipt of investment returns (be it bond payments or dividends).
e. With a premium/leverage financing approach utilized, a bank on an unaged policy would charge L+50bps, ideally at the 90 day rate to match/calculate the cost easier. On the other side, the insurance company is investing the proceeds to generate an investment return and those returns are deducted from borrowing cost. Over a year plus period, though the interest costs are not fully known, they are based on the insurance company risk versus that of the individual. Over a longer time-frame (though not potential multi-decade policy timeframe), there are a couple of ways the premium financing costs can be fixed; 5-year MTN’s, floating/fixed swaps. Any approach used to ‘fix’ will make the financing portion more expensive under a normal yield curve.
f. You also mention a policyholder having to payback a premium policy loan. The product I know would have never allowed a policyholder to be in this position. That is because investment assets dedicated to the policy is undercollateralized against the insurance company, and would not be tolerated at all by the bank. The collateral position (insurance investment portfolio) was audited at least once during the first year. In addition, covenants were put into place to insure/limit level 3 asset valuations.
a. The product I know overall appears to be very similar to a universal policy. It is permanent insurance, whereby premiums are due/paid quarterly. A person pays the annual premium (1/4 of annual each quarter) associated with their age/health risks per the insurance underwriting, therefore all thing being equal, the premium will rise as a person ages. In this case the premiums for each year are stated upfront for the life of product.
b. You make the most important point about the product; uncertainty of sequential returns (both borrowing costs and investment returns) over the potential life of the product. Especially as it relates to insurance companies that tend to be more risk adverse relative to other asset manager types, partially due to mortality and regulatory requirements. It is also the essence of the premium financing risk; if the returns don’t come to fruition, the policyholder will have to make up the difference in premium relative to the investment return credited to the policyholder. My guess is that a person facing this situation for a year plus will be doing some soul searching to determine if they truly need ‘permanent life insurance’.
c. For the product I know/dealt with, I am unaware of any insurance stated ‘guaranteed returns’. By borrowing/leveraging the amount of invested amount pay future premiums, there are assumptions made with respect to expected returns over time.
d. Where we diverge a bit is around the premium financing aspect of the product. You mention paying quarterly is a bad idea. The product I know didn’t charge an additional finance charge, rather the annual premium was divided into four equal payments without a stated finance charge. If a charge was built into the annual premium itself, that is certainly possible. My guess is the quarterly approach was chosen to match cashflows between the premium and receipt of investment returns (be it bond payments or dividends).
e. With a premium/leverage financing approach utilized, a bank on an unaged policy would charge L+50bps, ideally at the 90 day rate to match/calculate the cost easier. On the other side, the insurance company is investing the proceeds to generate an investment return and those returns are deducted from borrowing cost. Over a year plus period, though the interest costs are not fully known, they are based on the insurance company risk versus that of the individual. Over a longer time-frame (though not potential multi-decade policy timeframe), there are a couple of ways the premium financing costs can be fixed; 5-year MTN’s, floating/fixed swaps. Any approach used to ‘fix’ will make the financing portion more expensive under a normal yield curve.
f. You also mention a policyholder having to payback a premium policy loan. The product I know would have never allowed a policyholder to be in this position. That is because investment assets dedicated to the policy is undercollateralized against the insurance company, and would not be tolerated at all by the bank. The collateral position (insurance investment portfolio) was audited at least once during the first year. In addition, covenants were put into place to insure/limit level 3 asset valuations.
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