Our topic is adaptability – so hard to practice, particularly in politics, especially when regulations are involved.
It recalls Uncle Charley, a thorn to his brother, my grandfather, Papou. Charley, somehow: his real name was Atticus. He came over from Constantinople in 1915, right after Papou. When we met in the 60s, he spoke without accent, followed the Bruins, let his daughters play volleyball. This mortified Papou, whose accent was lifelong and who never stopped fighting the Turks, except when he met them for coffee.
Charley adapted to America; Papou remained the big-city immigrant. It didn’t hurt anyone, living the old ways. Congressmen who’ve fathered a bill get this way: they don’t want their creation forgotten, even if it’s moribund.
Some folks are just stubborn. Yet sometimes, even the most obdurate create a new day – not uncommonly, as in today’s case, at the last possible moment.
Congress’s omnibus bill that rang out 2020 included a small triumph for insurers and their customers. The Consolidated Appropriations Act, 2021 (CCA), an amalgam of last-minute spending bills, introduced changes to Internal Revenue Code 7702, the vehicle that adjusts the key interest rates defining tax-advantaged permanent life policies.
This is important, because IRC 7702 has been governing these definitions since 1984. In those distant days, when my hair, clubbing attire and romantic soul were uniformly black, interest rates were startlingly higher. Crucially, too, the cash value of permanent life insurance, a prime tool for estate planning today, wasn’t yet so important for clients.
President Trump signed the Act on December 27, 2020. CCA introduced dynamic interest rates for conducting life insurance qualification tests under IRC 7702. This small adjustment brought terrific relief to insurers.
In the old times, regulators believed life insurance, specifically those permanent policies with cash value accounts, should be used solely for their primary goal: providing benefits to heirs at the policyholder’s death. In 1984, they worried that life policies might become risky investment vehicles, undermining their essential role in society.
If I could spring from a big ‘n tall time machine, I’d tell those legislators not to worry; in the halcyon future, we do it that way and thrive. If it suits the estate plan, it suits us, too. What are you thinking? That business is static?
The problem was taxes. Whole and universal life are special pets of the IRS – our lobbyists have seen to it, you’re welcome – and treated with respect and understanding in distinction to many other investment classes.
In that old country, congressmen worried insurers might start gaming the system. I wouldn’t call them contrary or ignorant: our industry was different 40 years ago, and they focused on our irreplaceable role in protecting families and business continuity. Legislators feared we’d lose sight of the ball, charge after alpha, forget all those heirs and legacies. It’s like two brothers fighting: hard to fathom. Chalk it up to failure to communicate.
I get it, to a point. Historical fact: reasonable people can go haywire. Consider the Global Financial Crisis, if you dare. Intelligent financiers greedily sought self-destructing assets, which got tied up with banks funding government debt, et cetera. Profits distracted from the sizzling fuse and it all turned ghastly. Foot-shooting predates the GFC, so perhaps Congress thought. We like you insurers and we’ll meet you for brunch, but trust must always be verified.
I’ve said it before; pity the insurers. Legislators and regulators may suspect us, yet often they listen. That’s because we’ve nothing to gain from harming our clients. We profit from caution; one could say it’s the heart of our business. I don’t think the 1984 regs were meant to cause harm. It’s just that the old world, like my hair tone, has slowly faded away.
IRC Section 7702 set the rules that legally defined life insurance for tax purposes. It’s arcane but makes sense once you’ve examined it calmly. Life insurance contracts must meet the requirements of state law and pass actuarial hurdles. The regs limited two things: a policyholder’s premiums and the cash value that could accumulate in a permanent life policy. These factors were set in relation to the policy’s death benefit.
The math could stump Pythagoras; it’s harder to figure than a dot-matrix printer, as we used to say in the ‘80s. Insurers just shrug, carry on.
Crucially, Section 7702 defined the lower limits of interest rates used in those actuarial models. These minimum rates, established in the days of post-punk and Reagan, still applied in 2020. In 1984, that memorable year, the federal funds rate beat 10%, while this week, it’s 0.25%. A 10Y T-bill paid 11.67%; today, you’ll reap 1.45%. Insurers were struggling with low rates long before the pandemic, and how they’ve survived last year’s shocks is a wonder.
CAA 2021 adjusts Section 7702 by establishing a dynamic interest rate model for calculating the statutory minimum rate. The interest rate used in these actuarials now fluctuates in line with market rates. How so reasonable a law got through Congress is astonishing, yet I’ll refrain from sardonicism – let’s just enjoy this rare triumph of good sense.
Insurers needed to move quickly so as to adjust their products to the happy new reality. They had only days to comply: the bill passed on December 27 and became law on January 1, 2021. There’s always a bit of tarnish on the shiniest regs. Some products will need recertification by state regulatory agencies, too, never a happy prospect, but doable. Clarification and new instructions can be expected throughout the year.
Regulatory change, whether wise or dull headed, inflicts pain. Yet I’ve heard no one complaining this time: the change is a clear win for the industry and clients who favor permanent life products.