Low interest rates are great if you are borrowing money, but not so great for an insurance company trying to make a profit. That might also be bad for you because it leads to higher rates. To understand why lower interest rates are bad for insurers, you need to know how these companies make a profit.
If you own a typical permanent life insurance policy (lifetime coverage) and did a straight present value calculation of the premiums you can expect to pay during your lifetime, the total will be less than the death benefit. If the insurer is not collecting enough premiums to equal your death benefit, how do they make a profit?
Part of what determines the appropriate premium amount to charge a customer is based on the insurer’s assumed rate of return on its long-term investments. Insurers are extremely careful investors and on average, approximately three quarters of their investments are in government bonds. In addition, the federal government monitors these investments to make certain that they are low risk. The problem for insurers is that these types of investments are offering extremely low rates of return when compared to recent the past.
When investment returns reduce, the premium inputs need to be increased. A permanent life insurance policy that was purchased years ago may have needed $800 per year of premium based on the interest rates at that time. Today, that same policy might need $1,200 per year. With rate guarantees preventing insurers from increasing the rates of existing policy holders, many Canadian insurers have been forced to increase the cost of new permanent life insurance purchases by up to 50%, and more increases are likely.
Another important factor in determining your insurance premium is the insurer’s assumption of how much revenue will be generated by customers that lapse their policy before a claim is paid. It’s normal for a significant percentage of policies to lapse as customers leave due to changing needs, or in favor of less expensive alternatives. However, with the cost for new purchases of permanent life insurance products rapidly increasing, fewer customers will be interested in cancelling their existing policy in favor of alternatives. The result is less lapsed policy revenue to offset claims and this leads to increased rates.
In addition to insurance rate increases, here are a few other ways you could be negatively impacted by lower interest rates:
Universal Life (UL)
A typical UL policy is a permanent life contract that gives the customer control over how part of the premiums are invested. The benefit of owning this type of policy is that you can grow the investment portion and use it to pay future premiums or to enhance the death benefit.
If you were looking at a UL policy purchase today, it’s likely that you would make very conservative assumptions about the investment returns. However, many people bought UL policies when much higher rates of return were considered realistic. For these people, today’s low rates of return are having a dramatic impact on their original assumptions. If you have an older UL policy, you’d be wise to dust it off and talk to your broker about your original assumptions.
Insurance proceeds to be used as an income for a surviving spouse
Life insurance is often used to maintain a family’s income in the event of the breadwinner’s death. This strategy typically assumes that the insurance proceeds will be invested and that most, or all of the returns will provide the insured’s survivors with an adequate income source for as long as needed.
If you bought life insurance as a way of providing an income for your family, you really need to revisit your coverage amount. Even if the policy is only a few years old, the face amount may be woefully inadequate given today’s investment realities. Know if, and how much, the current interest rate environment has affected your policy and plan accordingly.
Thinking about buying permanent life insurance?
If you’ve been thinking about buying permanent life insurance coverage, it’s time to act. There may be a few insurers that have been slower to react to the impact of lower interest rates, but that window is closing fast. The longer you wait, the more you will pay.
If you are a lawyer, you also owe it to yourself to look at the Canadian Bar Insurance Association (CBIA) Permanent Life insurance plan. I know it sounds like a plug for my employer, but this product is an incredible bargain when compared to the cost of similar policies. Although low interest rates may force a price increase in the future, existing clients are guaranteed against cancellation or future rate increases.
Like all other CBIA products, Permanent Life is available to all Canadian lawyers, their spouses and adult children as well as law firm staff. Visit barinsurance.com for more details or call 1-800-267-2242 (CBIA).