Living in a Low-Rate World: Time to Examine the Value of Your Life Insurance

Living in a Low-Rate World: Time to Examine the Value of Your Life Insurance

We’ve observed a curious phenomenon: many of our clients, who are otherwise intelligent, educated and experienced in life, seem unaware of how their investments grow.

One of our agents was talking to a friend, who swore he’d never get involved in the stock market: it’s too volatile, murky, even immoral. How do you invest for retirement, our colleague asked? Oh, I’m in a mutual fund, came the answer.

This lack of enlightenment extends into the realm of life insurance. Some customers believe their policies are solid as Gibraltar, with a cash value, dividend and death benefit as assured as tomorrow’s sunrise. They’re apparently unaware that a policy’s underlying value is linked to the bonds and other investment vehicles the insurers use to create their products.

Interest rate movements have a powerful effect on the value of these basic investments – an obvious characteristic, assuming one knows the fundamentals. Low interest rates have persisted for many years and indications suggest they may trend lower. Now is a good time for life policy holders to examine the performance history of their policies, with the same critical eye they cast on any investment. Any disappointment should spur a rapid reaction.

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Low rates affect the myriad insurance products differently, but overall, if interest rates rise, yields will improve, thereby boosting a policy’s value. Carriers and informed clients have been patiently waiting for a rate boost, with their hopes long disappointed. Insurers are often finding it hard to meet the performance standards initially offered with products, and customers – those who’ve taken a strong look at their policies – might have good reason for disappointment and concern.

When a life product offers specific dividends or rates, these performance indicators are usually based on assumptions that current market conditions, wherever they stand when the policy is issued, will remain constant over the life of the product. In the 1990s, for example, dividend rates of 10% could be found. That’s what the sales illustration would have indicated for the policy’s lifecycle, likely influencing a customer’s decision to buy a policy. Unfortunately, the real dividend interest rate has dropped over the intervening 30 years to the current 5%.

This could leave some customers in difficult circumstances, as a key asset’s underperformance can undermine an entire financial plan. Likewise, carriers are left holding the bag, particularly in situations where products include performance guarantees. If major assets fail to perform, the providers are forced to respond, for example by cutting dividend rates on whole life policies, increasing insurance costs to customers, or shrinking the crediting rate for universal life plans.

Interest rates show no signs of recovery on the observable horizon. How should clued-in customers respond, with the assistance of their agents?

First, consider the original financial goals that underpinned a policy’s purchase. If the plan is meeting its goals, well and good, but if not, steps must be taken to avoid undermining the total financial scheme. If a higher premium is required by the provider, a customer can reduce the death benefit to a level where no further payments are required until maturity. A similar result can be achieved by exchanging a policy for one with a lower, paid-up death benefit.

An underperforming policy can be sold on the secondary market, and a new one purchased under terms that better fit the client’s situation. Finally, the client can simply surrender the policy and take the current cash value, and move into a potentially more lucrative investment.

For more information, please read:
How Low Interest Rates Affect Your Life Insurance Policy | Moss Adams

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