Interest Rate Interplay: A Chief Actuary’s View

by Janet Gossage, FSA, Chief Actuary

In March we read about the Federal Funds rate dropping to .25%. About that same time, we started seeing carriers announce many changes to their product portfolios. So, the obvious question is, what is the relationship, if any, between the two? The quick answer (but more below) is that life insurance products have interest rate risk. Both dramatic downward interest rate moves and stagnantly low interest levels that seem to have no end in sight produce significant risks for a life insurance company to manage. To reduce this risk, companies will take action.

We have been very busy the last couple of months updating our benchmarks with product changes due to the “low interest rate environment”. To be exact, since March 20, the day we shut our physical office and began working from home, we have seen 10 premium changes on no-lapse guarantee products, 8 revisions on term pricing and over 30 separate products with cap decreases in one or more accounts. Over about the same time frame last year, we saw one NLG reprice, 13 term updates, and 3 cap decreases.

Ultimately, a continued downward interest rate environment impacts the return a life insurance company gets on the assets held in its general account. Life companies are conservative investors and have a large percent of their assets in bonds with a duration of about 10 years. When interest rates are dropping, new premium dollars coming in are invested in lower yielding bonds, and bonds in the portfolios that are maturing are reinvested at lower yields. So how do the carriers compensate and adjust when they expect a lower return on their own investments? In many cases, they move to decrease the interest earned on their insurance offerings – decreasing either current crediting rates or cap rates. Always remember, IUL products are general account products and can be impacted by lower returns on the assets in the general account. On most products, the company holds a target spread between what they earn on the assets and what they credit to the policyholder. However, a carrier may not be able to achieve their full spread on some older current assumption and accumulation universal life products (CAULs) where they have higher guaranteed rates (like 4%), so they may not be achieving the level of profitability they targeted on those blocks of business. This is also why guaranteed rates on CAUL products have been at an all-time low. For the past couple years, guaranteed rates on these universal life products have continued to stay around 2% to 2.5% on average.

None of this should come as a surprise from a historical perspective. If you have been keeping track, interest rates have been on a downward trend since the late 80s. There have been a few quarters or years where upward momentum made life insurance companies hopeful that the worst was behind them. In 1988, the Federal Funds average yield was about 7.5%. As we all know, in March of this year, the Fed cut rates back to .25%. That’s over a 95% loss to the yield in just over 30 years. To frame it from the insurance product perspective, universal life offerings were using illustrated rates of at least 10% in the late 80s. Around 2007-2009, current illustrated rates on accumulation universal life products were cut in half (around 5%). On universal life policies bought today, the current illustrated rates are generally in the 3-4.5% range.

Over the next few months, the forecast is more of the same. The pandemic and the economic impact are likely to continue the downward pressure on rates. This translates to the potential for a surge in revisions within different product lines as NLG premiums continue to increase while crediting rates and cap rates experience decreases. We are here to help you stay on top of all the changes. LifeTrends consistently and swiftly tracks all product changes with our news and product overviews. You can also find a rolling 12-month report of the interest rate changes and cap changes in the Benchmark section of our website.