A component of policy pricing and illustrations is the assumed lapse rate for blocks of similar policies. The lapse rate assumption is a two-edged sword that can have adverse effects if it is either over estimated or under estimated. Although most experts expect lapse rates for survivorship policies to be two to four times lower than for single life policies, there has not yet been enough experience to know for sure. If a product is priced for a number of early lapses, the company may have a problem if the lapses do not occur as expected. The company will have to pay higher death benefits than assumed and higher cash values on later lapses. However, if more policies lapse and they lapse sooner than assumed, the company pricing will not include sufficient loadings to recover initial policy issue expenses and commissions. In either case, remaining policyowners ultimately must pay the cost of incorrectly estimating the number and timing of policy lapses.
It is generally not easy to discover what lapse rate assumptions a company uses. One may acquire general information from the state department of insurance or ask the company to provide the assumptions in writing.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM