Low Interest Higher Premium

Premiums on some universal life insurance policies are rising significantly, perhaps surprising many older Americans who have not been closely monitoring their policies. A big reason: the long-running, low-interest rate environment.

What’s the connection between higher insurance premiums and lower interest rates? Short answer: Life insurers’ assumptions about interest rates, upon which payments are calculated, are falling short of economic reality.

Long answer: Low interest rates mean low income from high-grade corporate bonds and U.S. Treasuries, which insurers hold to maturity. This income, along with the premiums paid by policyholders, pays for most of the cost of insurance.

When interest rates are this low for this long, it can force insurers to raise the cost of insurance, and raise premiums. Cost of insurance charges, for administration and other expenses, are deducted from the premium based on the insured’s age and other factors.

And the cost of insurance increases can be fairly significant: Transamerica, as an example, has increased the cost of insurance for some policyholders by amounts of between 20% and 40%. This can mean a hike in the amount the policyholder pays into their policies via premiums, or it can mean less of the premium payments go into the cash value of the insurance policy – or both.

This creates a double-whammy for those in or near retirement. Almost a decade of low-interest rates has already made it hard for savers who are trying to preserve their nest eggs in low-risk fixed-income investments.

Universal life insurance policies are different from fixed-cost, fixed-benefit term life insurance. Term life insurance covers the risk of death during the defined time period of the policy, and the policyholder does not receive any benefit if he or she outlives the policy. Universal life is a type of investment, with premiums deposited over time. Any remaining cash value of the policy, after the cost of insurance is deducted, goes back to the policyholder at the end of the term. It also allows the policy owner to adjust the cash value, death benefit and premiums. In the early 1980s, when interest rates peaked at about 15%, universal life insurance policies accounted for a quarter of all life insurance sold to individuals.

Because of the ongoing low-interest rate environment, insurers such as AXA, Transamerica, Phoenix, Voya Financial and Banner (Legal & General America) have announced cost of insurance increases for their existing universal life policies.

Sadly, many universal life buyers are not aware of the influence of interest rates on their policies, and the fact that cost of insurance charges can increase. In fact, a policyholder may not realize that the cost of insurance is eating up the cash value of the policy.

Too often, people buy insurance based on the premium, and the premium is not really the entire cost.
What can someone do when faced with a surprise increase in premiums and the cost of insurance?

Well, they can pay a higher premium, exchange their policy for a different type or allow it to lapse.
They could also reduce the death benefit of their policy, which will increase their period of coverage.

For a healthy retiree, it might be the best choice, as it, essentially, extends the life of the policy in return for less of a payout. For someone with a terminal illness, this might not be the best option.
Some insurance experts also recommend “no-lapse guarantee” policies under which an insurer cannot hike premiums for the life of the policy or a long period of time.

The cost of no-lapse guarantees have increased of late and availability also has been reduced. This is a form of protection available for higher premiums due to the cost of insurance increases.

The future? It is uncertain whether even higher insurance premiums could lie down the road for some policyholders. In theory, premiums could also drop if a sharp and sustained increase in interest rates occurs. Basically, it’s up to the financial markets upon which the insurers rely.

Insurance can be complicated; it’s smart to find someone who can help you. Ask your agent or your insurer for what is known as an “in force illustration” on their existing policy.
Bottom line: People must educate themselves. Ask about balance sheets and an insurer’s history of increasing costs on existing products. Research insurance products like any other investment.