1. CIA Annual Meeting LOOKING BACK…focused on the future

2. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future Pricing and Modeling Issues created by Universal Life Flexibility Bob Brown, FCIA, FSA, MAAA Valani Consulting Inc.

3. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future Pricing for Product Flexibility Universal Life is marketed and sold as a powerful financial planning tool Many options available at issue, with significant flexibility after-issue Reflecting this flexibility in pricing can be a challenge

4. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future Pricing for Product Flexibility How well do we understand profit sensitivity to premium patterns and face amount changes? Typical pricing approach is to model or sensitivity test a few funding level scenarios The reality will produce a wide range of outcomes

5. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future 1. Premium Timing Example 15 Annual Pay UL to target FV = Face Amt at age 100 What happens if Yr 2+ premiums are paid 1 day early? $1 of premium in yr 1 between Min – Max generates $0.15 of commission

6. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future 1. Premium Timing Example Profitability Impact 25% reduction in profit resulting from commission arbitrage

7. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future Pricing for Product Flexibility Face Amount flexibility can also have pricing implications Early face amount reductions can have negative profit consequences:  Issue costs and first year commission typically recovered from margins in COI / fund spreads  Often no commission chargeback after 24 months.  Do surrender charges apply on coverage reductions – is this being priced implicitly?

8. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future 2. Face Amount Optimizer Scenario YRT UL with Face Amount automatically set to minimize insurance costs each year (commencing end of year 5) Profit Margin is entirely eliminated with shortened pay period Two sources of margins are affected simultaneously: Reduced margins built-in to YRT scale (as NAAR collapses) Reduced investment spreads due to lower funding level in policy

9. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future Pricing for Product Flexibility Remedies available to the Pricing Actuary: i. Assumption setting: Analyze historical premium persistency patterns by duration Analyze actual surrender charge revenue vs expected ii. Product Design Better match of expenses and revenue or product design restrictions Ensure contract wording and administration system are consistent with pricing intention

10. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future Effective Universal Life Modeling Product options and flexibility create the need for 1000’s of cells to price a full portfolio Model complexity increases the risk of error and reduces resources available to analyze profitability and key pricing risks

11. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future Effective Universal Life Modeling By Definition a ‘model’ is a representation, and cannot anticipate everything Consider a different modeling approach for various uses: For initial pricing and analyzing assumption sensitivity use the 80/20 rule and focus on high distribution cells Complete pricing of low distribution cells by targeting desired profitability Foundation for business projection models (i.e. DCAT or EVA) and seriatim valuation

12. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future Effective Universal Life Modeling UL products often have a variety of embedded options and guarantees:  Interest Rate guarantees  Seg fund type death benefit guarantees  Fund Bonus structures  No lapse provisions  Fund payout on CI / disability

13. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future Effective Universal Life Modeling How are these options / guarantees being reflected in pricing? Deterministic scenarios to assess impact of early fund withdrawal Stochastic modeling could be used to quantify and price option type risks: Ex: Using stochastic scenarios find the cost of a specific interest rate guarantee, and express as a % Fund expense in pricing

14. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future Effective Universal Life Modeling Given the complexity and size of UL pricing models, a peer review process should be standard practice (internal or external) In reality, this process can easily breakdown due to tight time-to-market and scarce resources. Tight margins and significant guarantees provide little opportunity to recover from pricing errors  An ounce of prevention is worth a pound of cure!

15. CIA Annual Meeting Session 5107: Advanced Universal Life Pricing LOOKING BACK…focused on the future …In Conclusion The inherent flexibility of UL dictates a more dynamic pricing and modeling process A better understanding of how the product is marketed and sold can provide useful insights. Look to your inforce block for more than just demographics and actuarial experience => consider policyholder behaviour Thank you!