How life insurance buyers should factor in rising rates

Because of the falling-interest-rate environment that followed the 2008 financial crisis, many life insurance companies that invest mainly in fixed-income instruments were driven to increase prices for their guaranteed products. Facing the prospects of further increases, clients interested in fully guaranteed life insurance were encouraged to buy as soon as they could.

But even as interest rates start to climb again today, people shouldn’t expect a corresponding fall in the price of guaranteed products. “[I]t is important to understand that rising interest rates are only one of several components of life insurance product pricing,” noted Marko Djuranovic and Eric Naison-Phillips of Winged Keel Group in a piece for WealthManagement.com.

The two noted that various life insurance companies that introduced fully guaranteed products 10 to 15 years ago made “overly optimistic interest rate assumptions,” which means companies will likely be cautious in increasing their long-term assumptions for bond yields over the next 30-40 years. Since guaranteed life policies have low cash values, they would also require insurers to tie up significant amounts of capital to comply with reserving requirements, which may increase with rising rates.

“Therefore, in addition to weighing future interest rates, an insurer must also consider the overall cost of tying up capital in reserves for a product,” they wrote.

Individuals must also weigh the increased costs they stand to pay as they age. Prices for guaranteed life insurance may decrease with rising rates, but the dollar amount of premiums they pay could still increase overall as people’s health generally does not improve with age.

To take advantage of rising interest rates, Djuranovic and Naison-Phillips suggested that clients opt for lifetime premiums instead of 10 years or less. Not only does it allow policyowners to have more free capital to invest elsewhere, it also provides a hedge against sustained inflation as “future premiums will be paid with inflated, less valuable currency.”

Another option they suggested is to shift part of the coverage to guaranteed variable universal life policies, which have the same guaranteed features as guaranteed universal life. GVUL holders also have the option of investing the cash value of the policy in mutual funds, which lets them participate in the upside of positive performance.

“Given that a rising interest rate environment is often correlated with rising equity markets, this product gives the policyowner the opportunity to capture the benefits of a rising interest rate environment,” they said. “These policies may also build significant cash value, which is held in a separate account and is not subject to creditors of the life insurance company.”\