Closed block

What Is a Closed Block?

A closed block is a segregated group of insurance policies and their corresponding assets, established by an insurance company, typically when it undergoes a fundamental change like demutualization. Within the realm of financial services, particularly in the insurance industry, a closed block is designed to ensure that the reasonable dividend expectations of a specific group of policyholders are protected. The policies within a closed block are no longer actively sold to new customers, meaning no new business flows into it, but it continues to service existing obligations until the last policy terminates or matures. The assets and liabilities of a closed block are generally managed distinctly and are often subject to specific regulatory oversight, with their performance typically reported on the company's financial statements.

History and Origin

The concept of a closed block primarily emerged in the United States during a period of significant change for mutual life insurance companies. Historically, mutual insurers were owned by their policyholders, who received dividends based on the company's overall performance. When many of these companies began to convert from mutual ownership to stock ownership (a process known as demutualization), a mechanism was needed to safeguard the interests and dividend expectations of existing participating policyholders, who would no longer be the sole owners of the company.

The establishment of a closed block ensured that a defined pool of assets would be set aside to support the liabilities and dividend obligations of the policies issued before the demutualization. For instance, when Metropolitan Life Insurance Company converted to a stock company in 2000, it established a closed block to protect its existing individual life insurance policyholders⁷. The Actuarial Standards Board, through its Actuarial Standard of Practice No. 33, further detailed the actuarial responsibilities associated with managing these blocks, emphasizing the need to preserve policyholder dividend expectations during mutual life insurance company conversions⁶. This approach allowed insurers to raise capital or pursue strategic initiatives through their new stock structure while upholding commitments to their legacy policyholders, often following complex mergers and acquisitions.

Key Takeaways

A closed block is a ring-fenced group of existing insurance policies and associated assets, primarily created during the demutualization of a mutual insurer.
Its main purpose is to protect the dividend expectations and contractual obligations of policyholders whose policies were issued prior to the insurer's conversion to a stock company.
No new policies are added to a closed block; it only services its existing book of business until all policies mature or terminate.
The assets within a closed block are generally segregated and dedicated solely to supporting the liabilities and dividends of the policies within that block.
Closed blocks are subject to strict regulatory oversight to ensure policyholder interests are upheld.

Interpreting the Closed Block

Interpreting a closed block involves understanding its isolation and purpose within an insurer's broader operations. It is not an active business segment aiming for growth but rather a carefully managed "runoff" portfolio. The primary goal of a closed block is to manage its assets and liabilities such that it can fulfill all policy obligations, including discretionary policyholder dividends, until the very last policy expires. Actuaries and financial managers continually monitor the experience of the closed block, comparing actual cash flows and claims against initial assumptions. Any deviations in experience—such as higher or lower investment returns or claims—can lead to adjustments in the total dividends paid to closed block policyholders, as mandated by the block's operating rules.

T⁵he effective management of a closed block is crucial for an insurer's overall solvency and reputation. It ensures that commitments made under older policies are honored, often involving significant reserves dedicated to these long-term liabilities.

Hypothetical Example

Consider "EverSure Mutual Life," a well-established mutual insurance company that decides to demutualize and become a publicly traded stock company, "EverSure Inc." To protect its long-standing participating policyholders who have traditionally received dividends, EverSure establishes a closed block.

Creation: On the effective date of demutualization, EverSure identifies all participating individual life insurance policies and annuities that were in force prior to the conversion. These policies form the "EverSure Closed Block."
Asset Allocation: A specific pool of assets, including investments and other financial instruments, is legally allocated to this closed block. The value of these assets is determined by actuaries to be sufficient, along with anticipated future premiums from these policies, to cover all projected policy benefits, expenses, taxes, and the continuation of the policyholder dividend scale.
Operations: The EverSure Closed Block operates independently. It collects premiums from its existing policies and pays out benefits, surrenders, and dividends. The cash flows generated by the closed block's assets are solely dedicated to supporting the policies within that block.
No New Business: EverSure Inc. (the new stock company) can now issue new policies and annuities to new customers, but these new policies are not included in the EverSure Closed Block. The closed block remains "closed" to new entrants.
Monitoring: Over the years, EverSure's actuaries regularly review the performance of the closed block. If investment returns are better than expected, or if claims experience is more favorable, the additional earnings may be distributed to closed block policyholders as increased dividends, always in line with the initial objective of preserving their reasonable dividend expectations. Conversely, if experience is worse, dividends may be adjusted downwards.

This example illustrates how a closed block serves as a protective financial mechanism during a major corporate transformation, ensuring the integrity of promises made to a specific segment of existing customers.

Practical Applications

Beyond demutualization, closed blocks have several practical applications within the insurance and financial sectors:

Exiting a Line of Business: An insurer may decide to stop selling a particular product line (e.g., a specific type of universal life insurance or a niche annuity product). The existing policies for that product line, along with their supporting assets, can be placed into a closed block to manage their runoff efficiently. This allows the company to focus its resources on more strategic or profitable ventures.
Legacy Block Management: Many insurers have older portfolios of policies that, due to their age or product design, are no longer profitable or strategically aligned with the company's current business model. These "legacy" blocks can be formally recognized as closed blocks to facilitate their specialized management, often involving efforts to reduce operational costs or explore reinsurance options.
⁴ Mergers and Acquisitions Due Diligence: In the context of mergers and acquisitions within the insurance sector, acquirers often encounter closed blocks from the acquired entity. Understanding the structure, performance, and regulatory requirements of these closed blocks is critical for proper valuation and integration.
Monetization Strategies: Some insurers explore "monetizing" closed blocks, which involves selling the future earnings streams of a closed block to investors in exchange for immediate cash. This allows the insurer to reallocate capital to higher-return businesses. Rating agencies like AM Best evaluate such monetization strategies, assessing their impact on the insurer's financial strength and its ability to meet policyholder obligations. Ef³fective risk management and appropriate capital requirements are central to these transactions.

Limitations and Criticisms

While designed to protect policyholder interests, closed blocks are not without their limitations and criticisms:

Operational Costs: Maintaining a closed block can be costly. While new sales cease, the administrative expenses related to policy servicing, claims processing, and regulatory oversight continue, and can even increase over time as policies age and become more complex to manage. Th²is can lead to highly slim operating margins, as there's no new premium income to offset rising per-policy costs.
Technology Debt: Often, policies within a closed block were issued using older technology platforms. Modernizing these systems for a run-off block might not be financially viable, leading to "technology debt" and inefficiencies. This can increase operational risks and limit the ability to optimize the block's management.
Diminishing Returns: As a closed block matures, its income potential is inherently limited. Changes in market conditions, such as sustained low interest rates, can lead to lower-than-anticipated investment returns for the assets within the block, impacting its profitability and potentially reducing policyholder dividends. This highlights the importance of robust asset-liability management.
Complexity and Lack of Strategic Focus: Closed blocks can divert management attention and resources that could otherwise be dedicated to more strategic, growth-oriented parts of the business. Their complex nature often requires specialized actuarial science expertise and dedicated operational teams.

Closed Block vs. Open Block

The distinction between a closed block and an "open block" or "active block" lies in their operational status and growth potential within an insurance company.

A closed block is a distinct and finite portfolio of existing policies that are no longer being sold to new customers. Its primary function is to fulfill the obligations of these legacy policies until their natural expiration. The assets supporting a closed block are typically segregated, and all cash flows are dedicated to managing the block and paying benefits and dividends to its specific group of policyholders. The size of a closed block's policy count and premium base will only decrease over time as policies lapse, mature, or claims are paid.

Conversely, an "open block" (or more commonly, a company's "active business" or "in-force block") refers to the ongoing operations of an insurer that actively issues and markets new policies. This segment of the business aims for growth, continually adding new policyholders and premiums through sales efforts and underwriting. The assets supporting an open block are part of the general account or specific product-line portfolios designed for active growth and new business acquisition. The confusion sometimes arises because a company's entire book of business is "in-force," but a closed block explicitly denotes a subset of that in-force business that is not accepting new entrants, contrasting with the active, growing nature of the open block.

FAQs

Q: Why do insurance companies create closed blocks?
A: Insurance companies primarily create closed blocks during demutualization (conversion from policyholder-owned to shareholder-owned) to legally protect the dividend expectations and benefits of existing participating policyholders whose policies were issued prior to the conversion. It ensures their original contractual rights are upheld even under the new corporate structure.

Q: Are closed block policies still managed like regular policies?
A: Yes, policies within a closed block are still actively managed. This includes collecting premiums, processing claims, administering benefits, and paying dividends. However, the management is focused on the efficient runoff of the existing book, rather than new sales or growth.

Q: Can a closed block run out of money?
A: A closed block is established with assets actuarially determined to be sufficient to cover all future obligations, assuming certain experience factors (like investment returns, mortality, and expenses). While there are no guarantees, the segregation of assets and ongoing regulatory oversight are designed to minimize the risk of a shortfall. If actual experience deviates significantly, dividends might be adjusted, or in extreme cases, the general account of the insurer may need to provide support.

Q: How long does a closed block typically last?
A: The duration of a closed block depends on the maturity of the policies within it. For long-term individual life insurance policies, a closed block can exist for many decades, potentially 50 to over 100 years, until the last policy within the block terminates.

¹Q: Does a closed block affect my policy benefits?
A: The intention of a closed block is to ensure that your policy benefits and reasonable dividend expectations are maintained, especially if you hold a participating policy from a mutual company that demutualizes. The specific terms and operation rules of the closed block are designed to protect these benefits, subject to the actual experience of the block.