Interest rates are climbing, and this has consumers studying the returns on their investments as well as the impact on their spending. The impact of rising interest rates can be directly correlated to the performance of many asset classes. For instance, as interest rates move upward, the rates of treasury notes tend to increase where the price of fixed rate bonds declines. But does this extend to the performance of a life insurance policy? Should a policyholder expect a policy’s dividend interest rate or crediting rate to move in step with interest rates? The answer is “yes” – but not necessarily right away, and with some policies not for some time.
Cedar Point Financial Services LLC understands how life insurance companies respond to changes in the interest rate environment, and what this behavior means for existing policyholders as well as for 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 interest rate or crediting rate, the insurance company must first benefit from greater returns from its general account investment portfolio where premiums are invested. In many situations, there could be a delay of a couple of years or more before these portfolios are able 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 interest rates and crediting rates, following the decline in interest rates in general. 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 Cedar Point Financial Services LLC can tell policyholders if their policies are 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 life insurance industry will likely 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 (and lag) 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 taking advantage of tax-free IRC Section 1035 exchanges, and reinvesting the proceeds in new UL, IUL or variable universal life (VUL) contracts.
When it comes to UL and IUL, there are more options than whole life for the life insurance company to consider when it comes to policyholder benefits. For example, instead of driving increased profits 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 due to reduced cost, since the ‘shadow account’ upon which the guarantee is calculated would benefit from a higher crediting rate.
Interest rate increases will almost certainly have a direct and consequential impact for policyholders with VUL contracts. Many VUL policies have fixed or interest rate sensitive investment options which can act to offset risk from other available investment options. These conservative options have suffered such low returns in recent years that policyholders avoided them. As their yields increase, policyholders will be more likely to take advantage of them in diversifying
Are you in doubt about the performance of your policy as interest rates climb? A Cedar Point Financial Services LLC analysis will tell you if any adjustments are needed, giving you peace of mind that your policy will continue to meet your planning goals.
A primary consideration for publicly-traded life insurance companies will be determining 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 currently. Rising interest rates may enable insurers to redesign products with lower premiums or accelerated cash values, resulting in favorable policy performance. Participating whole life products may also become more feasible options, since higher anticipated yields will allow for a more favorable illustrated dividend scale.
In an increasing rate environment, insurers may be able to return to offering higher yielding investment-oriented, fixed UL products by passing some of the increased yield to the policyholder through higher crediting rates. As a result, some insurers may pass that increased yield to richer, secondary guarantees, making guaranteed UL contracts more cost effective.
Rising interest rates can positively impact IUL policies in at least three ways. First, as with UL, the insurance company may be able to quickly increase the minimum crediting rate on new money IUL policies. Second, some carriers may forgo new money products and raise caps and participation rates on existing policies. Third, as interest rates have risen, more insurance companies are investing in volatility control index choices that reduce option costs and allow for the raising of performance ceiling caps and/or participation rates, permitting increased performance potential.
We Can Help
As interest rates rise, the team at Cedar Point Financial Services LLC is here to assist clients in evaluating the performance of their existing life insurance policies as well as helping them to navigate their choices for new coverage.