How low interest rates affect your life insurance policy
The following is a post by insurance specialist Glenn Cooke, president of InsureCan Inc.
We’ve been in a sustained low interest rate environment for a while now. While this is great news at mortgage renewal, this rate climate is having a dramatic impact on many existing life insurance policies as well as limiting options you may need to explore in the future.
The cause of the problem:
Here’s the start of the problem. When you buy a permanent life insurance policy, the insurance company is basically trying to save up your premiums so that they have your death benefit in cash when you die. If you’ve got a life expectancy of another 35 years, the company has 35 years to save up your death benefit.
Insurance companies being what they are want to invest these premiums in long term money. And right now, things like 30 year investments are basically providing a 0% rate of return. How does that affect your premiums? Well, at 6% it takes $846 per year to generate $100,000 in 35 years. But slash that interest rate in half, and it now takes $1605 per year to get to the same $100,000. Cut interest rates in half, and inputs need to be doubled. And again, it’s the long term interest rates that cause this problem on long term insurance products. (The effect is much lessened on term life insurance over 10-20 years).
In addition to interest rates, insurance companies use what are known as lapse rates in their pricing. If we have 10 people that buy insurance and 9 of them pay premiums for a decade or so but then cancel, the company only pays out 1 death benefit. 10 people paying premiums and one death benefit means they can lower premiums for all 10 (it’s why insurance premiums are often cheaper than what you’d expect if you just did a straight present value calculation of the death benefit). Problem is, under current conditions people are not cancelling their long term insurance policies at rates anywhere near what was expected. And again, that means there’s upwards pressure on long term life insurance premiums.
So basically, on long term life insurance products, premiums are going up.
In addition, on any insurance product that contains any sort of investment component, it means investments aren’t kicking out the great 6-8% that may have been assumed when you first bought the policy.
The result of these pressures is that in the past year most insurance companies in Canada have instituted premium increases of up to 20% on their permanent insurance policies. But the underlying problems aren’t going away, and by many accounts we can expect to see permanent insurance premiums increase by another 20-50% in the next year or so.
In short, the result is higher premiums for many new purchases of permanent life insurance policies going forward.
So why should you care?
Here’s a list of 4 substantial problems that can affect you directly.
1) Permanent insurance premiums are on the rise. And I don’t foresee them coming back down again in the near future. If you’re ever looking at purchasing a permanent life insurance policy, run, don’t walk to your nearest insurance broker and get those rates locked in now. If you have ever thought of purchasing insurance on your children for their future protection (putting aside the traditional arguments against this approach) again, now is the time to get those premiums locked in for their lifetime.
2) Interest rates inside your universal life insurance policy may have dropped. If you were expecting a specific cash value in the future say for your retirement, you may not meet your target. If you were expecting to stop paying premiums at some point in the future, you may find that you reach that point and still have to pay premiums.
3) Dividends on your whole life policy may have been lowered. We’re not talking stock dividends, but a peculiar life insurance type of dividend that drives many features of whole life policies. Drops in this type of dividend can mean lower cash values in the future than were expected. They can also mean lower insurance amounts and as in #2 above, a drop in dividends can mean that if you assumed your policy was paid up in the future (no more premiums due) you may find that in fact premiums are still payable at that point. For example, Sun Life announced at the end of January 2012 that they were lowering their dividend scale.
4) Even if you have term insurance now, your future options are likely to be more limited and more expensive. Many term insurance owners flip over to a small amount of permanent insurance around retirement age. And if you become uninsurable, you’ll almost certainly want to take advantage of the ‘conversion’ option available in many term policies to switch to a permanent policy. The choices available to you at that future point are rapidly becoming substantially more expensive and possible offering less choice.
There’s very little in the way of a quick fix.
If you were ever thinking about purchasing permanent insurance, it’s time to start thinking a lot harder and faster.
For those that currently have a whole life policy, universal life, or term to 100, go dust off your old insurance policy. Then call your agent or the company and ask for a current illustration.
Lastly, find out what your future values are estimated to be using current assumptions rather than assumptions used when you purchased the policy. Know if and how much the current interest rate environment has affected your policy so you can plan accordingly.
This article was written by Glenn Cooke.
Glenn has made some excellent points. The question is do you think interest rates will be low for a long time? I have personally converted most of my term insurance to permanent years ago. Now the same coverage at my (younger age would cost more).
Generally nobody likes insurance. The key is to consider looking at the end game. One example I used was annuities. Using permanent insurance one could get a high guaranteed rate of return and pay little taxes. So one get protection, for life for their family (works out cheaper than term insurance in the long run) and are able to lower their risk at a later point in their life and get to spend more money.
As one example people can relate to is if you could get a 1% mortgage rate lock it in for 10 ten years would you have to think about it? Or buy TD @ $25?
Those pesky low interest rates keep causing more and more problems, eh? This is one I haven’t thought of before.
Neither did I, until Glenn wrote such a great article…