Interest Rate Sensitivity

Interest Rate, Sensitivity, Data, LifeTrends, Life Insurance, Points, IUL, Retirement

Interest Rate Sensitivity

- By Sydney Presley, LifeTrends Sr. Analyst

It’s hard to know what illustrated rate is reasonable for an Indexed Universal Life product. Max rates use the caps and floors against historical data to determine a reasonable flat rate; however, it is easy to debate the applicability of the interest rate that results from the look back. The most obvious reason being: it is very unlikely that the historical look back will repeat itself exactly in the future. Most agents are also wary of any levers carriers can pull within a policy to lessen the return, such as a cap rate drop. The following is a test we performed to gain one perspective on these interest sensitive products.

What we did…
The test consisted of running 6% premiums at a 5% return, and focusing on when the policies lapse. We used a $1,000,000 death benefit and the premiums found for full pay, ten pay, and single pay scenarios when targeting $1 CSV at Maturity using a 6% interest rate. We then took those premiums and illustrated them at 5% instead* (so we named the premium and the death benefit). From here we looked at what age the policy lapses when using the lower 5% interest rate. To get a decent scope of each product, we compared male clients aged 35, 45, and 55, looking at both Preferred Best and Standard Non-Tobacco risk classes.

What we found…
While there were small exceptions throughout, we found that in this test, products will typically stay afloat to around age 90 for full pay scenarios with the best products sometimes lasting through the mid or upper 90’s (well beyond life expectancy). The limited pay cases fared slightly worse, but still lasted beyond the expected life of a client (typically mid 80’s). The most glaring exception to this rule was John Hancock’s Protection IUL 15. For this product, single pay scenarios would fail quite early; in most cases, within 10 to 15 years after being issued.

Next steps…
After the first test, our next question was: what would happen if you tried to catch the premium back up so that the product would last through maturity with the lower rate? To go into this question, we looked at a 45-year-old Preferred Best male. After 10 years, we looked at the catch-up premium (ongoing for full pay; single catch up for the limited pay structures) to get the policy to last through Maturity. For the most part in this limited scope, products seemed to behave in the same way – the catch-up premiums were in a fairly similar competitive position to the product’s solved for premiums. Meaning if a product is competitive, less premium would be required to catch it back up than a more expensive product. This note brings John Hancock’s product back into consideration: since their premiums are competitive at both 5% and 6% levels, a smaller amount of premium was required to catch it back up for a single pay scenario.

Moral of the story…
Monitor your client’s policy. A full percentage drop from the original assumption will cause a policy to lapse sooner, but you have at least a couple years to correct this if you want to ensure it is projected to run through age 121. It’s also good to be extra aware when doing a limited payment structure as these are more sensitive to the drop if left alone. If the policy requires a bit more premium, better to catch it sooner rather than later – otherwise you may risk an unwanted lapse.

Side note…
This can be applied when looking at the max interest rate and dropping it down, as well as any cap rate changes that a company may make. Dropping a cap by a full percentage point wouldn’t lower the maximum illustrated rate by much more than 50 basis points.

*In instances where the max illustrated rate was less than 6%, the illustrated rate was scaled down to have the same ratio loss as 6% to 5%.