Hidden In Stimulus Bill: A Win For Whole Life Insurers

Beginning this month, life insurers will start redesigning permanent life insurance products as a result of new calculations enacted via the Consolidated Appropriations Act, 2021 (H.R. 133), Moody’s Investors Service reported.

Although the CAA was largely a spending and stimulus relief bill, it also contained a provision that changed the determination of a minimum interest rate used in certain tax-related calculations for life insurance contracts. The determination of the new rate, which had not been updated since 1984, was changed to reflect the current lower interest rate environment. Moody’s said this is a credit positive for insurers, which will benefit from sales growth of permanent life insurance products because the new calculation makes these products more viable for insurers and potentially more attractive to consumers.

For sales starting at the beginning of the year, the CAA provision lowers the minimum rates that are used in determining whether permanent life insurance meets the requirements under Internal Revenue Code section 7702 to qualify for tax-advantaged treatment as insurance rather than being taxed as an investment. Lowering the rate leads to a higher cash value relative to the death benefit and allows consumers to put additional funds into a life policy without triggering modified endowment contract status, which has adverse tax consequences for the policyholder.

Section 7702 states that for a contract to qualify as a life insurance contract for federal income tax purposes, the contract must be a life insurance contract under the applicable law and must either (1) satisfy the cash value accumulation test, or (2) the guideline premium and corridor test. The GPT limits the amount of premiums that can be paid into an insurance policy relative to the policy’s death benefit.

The interest rate used is the rate in effect at the time the original contract is issued. The new rates are only applicable to life insurance contracts issued after Dec. 31, 2020. Additionally, the initial insurance interest rate is set at 2% for contracts issued in 2021 and will adjust prospectively with market interest rate levels.

Mutuals Dodge A Bullet On New Sales

Moody’s said the new calculations are credit positive for U.S. life insurers that sell permanent life insurance, a policy that offers cash value and a death benefit, enabling them more flexibility in pricing products in the current low rate environment. The calculations are particularly favorable for mutual life insurers that sell whole life insurance products. Before the change in section 7702, whole life policies needed a 4% minimum guarantee to avoid triggering MEC status after premiums payment had been completed.

Mutual life insurers were facing increasing pressure to provide this guarantee as market interest rates declined over the past decade and materially so in 2020. Yields on recent bond purchases are likely to be in the 4% range. Further declines in interest rates would have placed mutual insurers in an unsustainable position whereby they would need to provide a guarantee above the rate that they could reasonably earn on fixed income securities.

The new law reduces the required guarantee from 4% to 2% in 2021, which will adjust to market conditions over time. Mutual insurers now have much greater flexibility to be able to sell whole life insurance products even in very low interest rate environments, and have more flexibility with product design, such as with limited pay products.

Modest Credit Positive For UL Writers

Life insurers that sell accumulation-focused (as opposed to death benefit focused) permanent life insurance including universal life, indexed UL or variable universal life insurance would also benefit from the new regulations, Moody’s said. Policyholders will be able to put significantly more premiums per dollar of death benefit without being classified as a MEC and losing preferential tax treatment. The insurance policy would be more efficient in terms of cash accumulation. Although the COVID-19 pandemic made consumers more aware of the need for life insurance, leading to greater demand in 2020, this recent development is a potential benefit for the new year, assuming insurers can overcome implementation issues.

Implementation Concerns Must Be Addressed

Moody’s said implementation will take some time and require life insurers to reevaluate their product offerings. Many insurers will need to revise product pricing and obtain the necessary state regulatory approvals. The new regulations will require insurers to update their systems (for example illustration, administration, etc.). Not every company will be in a position to make these changes in a timely and efficient manner.

There could be some unintended consequences of the new regulation, according to Moody’s. One issue that needs to be considered is the impact to agent compensation. Agents are typically paid based on a target premium (tied to the face amount of the policy) times a percentage specified by each insurance carrier. Assuming a consumer has a fixed amount to invest in their policy, the new law would lead to a lower required death benefit to retain the policy’s insurance qualifications. All else equal, the lower death benefit would lead to a lower target premium and thereby lower agent commissions.

Additionally, there are various price discounts that insurers provide for bands of larger face amounts of insurance. A lower death benefit would typically lead to lower costs of insurance, but if the policy crosses over into a lower threshold amount and is not given preferential pricing, it might lead to increased COI charges for the consumer.