Interest rates are climbing, and this has consumers studying the returns on their investments as well as the impact on their spending. The Federal Funds rate was .83% on May 27 and it is expected to climb to at least 2.25% by the end of the year in response to recent inflation. The impact of rising interest rates can be directly correlated to the performance of many asset classes. For instance, the rates of treasury notes tend to increase where the price of fixed rate bonds decline as interest rates move upward. But what about the performance of a life insurance policy? Should a policyholder expect a policy’s crediting or dividend rate to move in tandem with interest rates? The answer is “yes” – but not right away and, with many policies, not for years.
Howard Insurance understands how life insurance companies respond to changes in the interest rate environment and what this behavior means for our existing policyholder clients as well as prospective ones.
For a whole life or universal life (UL) policyholder to benefit from rising interest rates with an increase to a policy’s dividend rate or crediting rate, respectively, first the insurance company must benefit from greater returns from their investment portfolios where premiums are invested. In many situations, there could be lag of a couple of years or more before these portfolios are in a position to pass along investment gains to policies.
While this can be frustrating, policyholders can take solace in that the process works in reverse when interest rates fall. As rates drop, insurance company portfolios have many long-term investments locked in at higher rates. As a result, there is a lag in the reduction in policy dividend and crediting rates following the decline in interest rates. If a policy is held for several decades, it is likely to experience periods of both benefiting from a delay in the impact of falling interest rates and being disadvantaged from a delay in the impact of rising interest rates.
A policy review from Howard Insurance can tell a policyholder if their policy is performing as expected under current conditions or if any changes are needed.
A Move toward New Money Products
According to a 2022 report from Oliver Wyman, “The Impact of a Rising Interest Rate Environment”, the life insurance industry is likely to pivot toward ‘new money’ products. These are policies that are supported by a life insurance company’s new or relatively new investment portfolio and include universal life and indexed universal life (IUL) contracts. New portfolios can take advantage of current interest rates where existing portfolios, usually those backing whole life contracts, will have a drag from prior, low interest rates. The result – the richer benefits and reduced cost of new money products will likely drive some whole life policyholders as well as owners of older UL and IUL to consider surrendering or conducting a tax-free IRC Section 1035 exchange to reinvest the proceeds either elsewhere or in new UL, IUL or variable universal life (VUL) contracts.
When it comes to UL and IUL, there are more levers for the life insurance company to pull than for whole life when it comes to policyholder behavior. For example, instead of driving profitability from higher earnings into the crediting rate, an insurer could choose to strengthen guaranteed features like the minimum crediting rate in a UL or IUL. UL with a guaranteed death benefit could experience an increase in sales since the ‘shadow account’ upon which the guarantee is calculated would benefit from a higher crediting rate.
These changes are not certain since life insurance companies do not have any historical data to study when it comes to how to treat interest rate sensitive products in a period of rising interest rates. Essentially, they will be making educated guesses on what features to improve to keep policyholders happy.
Where interest rate increases will almost certainly have a direct and consequential impact for policyholders is those with VUL contracts. Many VUL policies have fixed or interest rate sensitive investment options which can act to mitigate risk from other asset classes chosen for premium investment. These conservative options have suffered such low returns in recent years that policyholders avoided them. As their yields increase, so can the diversification of the overall policy account.
A primary consideration for stock life insurance companies will be for how much of an increase in portfolio yield to pass along to product features and performance and how much to push into profitability for its shareholders – always a tricky balance for these types of carriers. Mutual life insurance companies, owned by policyholders, should expect to see an investment in products with insurer portfolio performance driven back into benefiting their policyholders with attractive policy rates and features.
Traditional products, particularly whole life, which relies on long term asset yields to cover expenses and product requirements, have struggled under low interest rates for some time. This is demonstrated by the decline in dividend rates over the past thirty years from over 10% to around 5% and lower. Rising interest rates may enable insurers to redesign products with lower premiums or accelerated cash values, both of which would result in favorable sales illustrations. Participating whole life products may also become more feasible, with higher anticipated yields allowing for a more favorable illustrated dividend scale.
In an increasing rate environment, insurers may be able to return to offering high-yielding investment-oriented fixed UL products by passing some of the increased yield back to the policyholder through higher crediting rates. As mentioned, some insurers may pass that increased yield to richer, secondary guarantees, making guaranteed UL contracts more affordable.
On the other hand, equity-driven IUL products may become less appealing, particularly if an inverse trend between interest rates and equity market performance arises. As crediting rate guarantees become increasingly generous, prospective policyholders seeking less volatile gains may instead select fixed UL or whole life.
We Can Help
As interest rates rise, the team at Howard Insurance is here to assist our clients in evaluating the performance of their existing life insurance policies as well as helping them to navigate the choices for new coverage. For over 75 years, Howard Insurance has helped each of our select clients secure their assets, their ambitions, their businesses and, ultimately, their legacies. Leaders in life insurance, private insurance advisory, and risk management, we pair deep expertise with sincere attention to our clients’ needs to create unique solutions that benefit them best.