Interest Rates Are Up But Not In UL — Yet

By Linda Koco
InsuranceNewsNet

Interest rates may be rising, but life insurance agents shouldn’t be looking for any interest rate bump-up in universal life policies just yet.

That’s the word from the gurus who are looking at the numbers.

In a recent report, SNL Financial pointed out that “interest rates have been on a tear for the past two-and-a-half months.” The yield on the benchmark 10-year Treasury rose to 2.5 percent on July 19 from 1.7 percent on May 1, SNL pointed out.

By July 22, the yield had risen to above 2.6 percent though it didn’t stay there. Given that the 10-year dropped to below 1.5 percent at one point last year, that spike got a drum-roll.

Breathing again

People in the home offices of insurance companies are probably starting to breathe again, surmised Ben Baldwin Jr., owner of Baldwin Financial Systems of Arlington Heights, Ill., in an interview.

“Finally, some increase in interest rates. Finally, some hope that interest rates will someday, soon we hope, allow some positive margin again.”

That all-important margin might mean that producers could start seeing a positive impact on interest crediting rates -- a good-news story to bring to clients after the long drought of Down.

But not right now. “The new universal life products we are seeing this year generally have a 2 percent minimum guaranteed crediting rate,” said Michael Mingolelli Jr., chief executive officer of Pinnacle Financial Group, Southborough, Mass.  “This is down from about 2.5 percent last year,” he told InsuranceNewNet.

This means the universal life carriers are still trying to reduce their exposure, he said. “We have no expectation that this will change later this year.”

A key reason is the lag that traditionally exists between yields on bonds the carriers buy to support their contractual guarantees and the credited rates offered to customers.

In the current environment, Mingolelli explained, carriers will be buying bonds at today’s somewhat-higher-than-yesterday yields. But it will still take a while before the bonds purchased during the era of prolonged rock bottom rates fall off the books in appreciable numbers. Hence, the bond yields in company reserves will the lag those in the current rising rate environment.

And that means current crediting rates and guaranteed minimum interest rates also will lag.

Portfolios might take a year and one-half or more to catch up, Mingolelli said.

Remember, carriers buy and hold their bonds until maturity, he said. So the industry focus is always on the rates of the bonds the carriers purchase.

In an advisory his firm published on interest rate trends a year ago, the firm told agents and advisors that “clients should expect potential crediting rate reductions [emphasis added] of up to 50 basis points over the next three years.” Funding scenarios should be modeled with that expectation in mind, the advisory said.

“We are still recommending that,” said Mingolelli.

Another factor affecting the rates that universal life carriers can credit is the legacy business that remains in force. Some of those older policies have guaranteed minimum interest rates of 4 percent, pointed out Kenneth Masters, director of life insurance design and development at Pinnacle.

As a result, carriers that have those policies will tend to be cautious about raising their crediting rates in universal life, he said.

Catching the trend

To glimpse trending in universal life crediting rates, producers can look at corporate investment bond rates, Masters suggested. Those rates correlate well with the interest crediting that carriers do, he said. (As an example, he suggested using Moody’s five-year rolling average.)

Another area to examine is policy reserve levels. That’s not a go-to subject for some producers, but those who have a few minutes to spare might want to dig in because reserves can be revealing.

According to SNL, life insurance policies are not the only interest-sensitive products that could potentially be affected by the interest-rate environment. Those products also include disability insurance and long-term care insurance; these are considered interest-sensitive “due to the long duration of the policies and the difficulty in determining the frequency of claims,” the researchers said.

So are fixed annuities. These policies offer guaranteed interest rates and leave the insurer open to interest rate risk.

SNL decided to check out the aggregate reserves for the four types of interest-sensitive products between the years 2010 and 2012. To do their analysis, the researchers looked at data in the annual supplements on interest-sensitive policies that carriers file with National Association of Insurance Commissioners (NAIC).

At the top 30 life insurance companies, the aggregate reserves for the industry’s four interest-sensitive product lines rose 4.3 percent in 2011 to nearly $917 billion from roughly $879 in 2010, according to the SNL analysis. Measured by percentage, more than 60 percent of the carriers in the top 30 beefed up interest-sensitive reserves that year; the other carriers kept their reserves flat or dropped them by a hair.

The increase could be expected, given the interest rate environment, the researchers commented.

Spot on. Many carriers announced they were shoring up reserves at the time. “They were doing that because they anticipated that the insurance regulators would demand it of them if they didn’t,” observed Baldwin.

There are other reasons that can account for increased reserves, such as new regulations or substantial growth in new sales. But in 2011, most experts agree that the dominant factor was probably those downhill rates. After all, yields on 10-year Treasuries fell from 3.3 percent in early January to around 1.9 percent by year-end.

But in 2012, aggregate reserves went south at the top 30. The aggregates declined by 4 percent—to a little over $880 billion, according to the SNL numbers. That’s close to where reserves were in 2010.

This turn of events is a bit puzzling. Interest rates were still plummeting in 2012—to less than 2 percent on 10-year yields for much of the year—so wouldn’t the carriers have continued to hold or increase their reserves rather than reduce them?

Actually, they did. Pinnacle’s Mingolelli pointed out that most of the insurers in the top 30 last year reported increased reserves or reserves that stayed level with 2011.  Only six carriers, some of them big, reported decreases, so these outliers skewed the overall numbers.

In the cases were there were declines, “the culprit may have been fixed annuities” rather than disability, long term care or even life insurance trends, said Timothy Pfeifer, president of Pfeifer Advisory of Libertyville, Ill.

Some customers were 1035-ing out of fixed annuities due to the low interest rates last year, Pfeifer recalled. Meanwhile, many carriers had taken steps to slow down sales, and new buyers were staying away anyhow due to the low rates. So in some cases, there were not enough new sales to stabilize reserves, he said.

Putting it all together, it appears that interest-sensitive policy reserves may be a type of trailing indicator of what is happening in overall interest crediting, based on what has already happened.

It’s somewhat of a maze to sort through, but once the inquirer spots momentum, that can be valuable information to share with clients who are interested in interest.

Next three years

In the next three years, a “good scenario” for the industry would be a steady rate increase of 100 basis points per annum, said Chicago’s Fitch Ratings in a recent report on interest rate risk for U.S. life insurers.  “This scenario is favorable across all major product lines and particularly interest-sensitive products such as fixed annuities, universal life and long-term care.”

Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].

© Entire contents copyright 2013 by InsuranceNewsNet.com Inc. All rights reserved. No part of this article may be reprinted without the expressed written consent from InsuranceNewsNet.com.

Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].