At Miller & Newberg, we make every effort to alert our clients to industry developments that are not necessarily reported widely in the popular or industry press, but that nonetheless are very important for insurance companies and fraternal benefit societies to know and act upon.
A pair of those developments occurred on July 1, 2020:
- 1. The valuation interest rate for life insurance products, which has been steady at 3.5% since 2013, will be dropping to 3% for new business effective 1/1/2021.
- 2. For these same products, the maximum nonforfeiture interest rate will be dropping from 4.5% to 4% for new business effective 1/1/2022.
Both of these changes impact life insurance contracts with guarantee durations of 20 years or longer. For most companies, it means that all of their life insurance products are affected, even term insurance. This is because most term products do not terminate at the end of their initial term period, but rather have guarantees that extend at least 20 years.
It has been eight years since the last decrease to these rates, so you may be unaware of how disruptive this pair of changes can be. For your company, it means:
- New, higher reserve factors are mandated for new business on traditional life products by 1/1/2021. These factors must be calculated and implemented by then. Moreover, without other product changes, this could produce undesired deficiency reserves.
- If your company provided a demonstration or statement of the reserve method as part of your original product filing, informational filings with the appropriate regulatory authorities may be required.
- For your traditional life products that were not already using a 4% nonforfeiture interest rate, then new, higher cash value factors are mandated for new business on these products by 1/1/2022, at the latest, although your company can elect to make this change earlier. Without other product changes, this could produce undesired cash values on your term products.
- Since your policy forms include statements about and/or tables of minimum cash value figures, revisions and filings for approval are required with the states and/or Interstate Compact.
Given these changes and the low interest rate environment in general, it would also be a good idea to re-examine the profitability of each of your products to determine if other adjustments to premiums or features are necessary.
See the Q&A below for more details.
What is the life insurance valuation interest rate?
Statutory reserves for life insurance contracts are calculated using a set of mortality rates and an interest rate that are prescribed by state regulations, regulations that are based on the NAIC Standard Valuation Law. The regulations prescribe how the interest rate to be used is calculated, using a formula that is designed to respond to market interest rate conditions. In general, a drop in the valuation interest rate means that statutory reserves increase at every duration prior to contract maturity.
Why is the valuation interest rate changing from 3.5% to 3%?
Market interest rates, as you know, have fallen to unprecedented low levels over the last few months. The formula for determining the interest rate to use in setting reserves is based on a calculation that uses the lesser of the 12- and 36-month averages of Moody’s corporate bond yield indices. Because of falling interest rates, the calculation has now resulted in the first change to the valuation interest rate for life insurance contracts since 1/1/2013. The rate is changing from 3.5% to 3% effective 1/1/2021.
What contracts does this affect?
The reserve interest rate on contracts written through 12/31/2020 is not changing. That means that any reserve factors your company has programmed in your computer systems are fine for use on business written through the end of this year. However, this change does go into effect and is mandatory for all new business effective 1/1/2021, so your company must have new reserve factors in place by then.
Why is the life insurance nonforfeiture interest rate changing as well?
The same dynamic that causes the life insurance valuation interest rate to change also causes the maximum life insurance nonforfeiture interest rate to change. The rate is changing from 4.5% to 4%, required by 1/1/2022. This means that on any traditional life products that were not already using a 4% nonforfeiture interest rate, your cash value factors for new business need to change by then. In general, a drop in the nonforfeiture interest rate means that cash values for traditional life insurance increase at every duration prior to contract maturity.
Note that for cash values, this is an optional one-year delay from the valuation rate change. The reason for the delay is that while changes to reserve factors can be implemented by carriers without filing for regulatory approval, changes to nonforfeiture factors must be made to policy forms that then must be filed with and approved by state regulators or the Interstate Compact, so the regulators have allowed more time for the cash value change to occur.
For the nonforfeiture rate, there is one further potential development which could further change the rate. The nonforfeiture rate will become 4% under current law. The proposed HEROES Act being discussed in Congress has a provision whereby Internal Revenue Code §7702 would be modified such that the new nonforfeiture rate would instead become 3.75%.
What must my company do, at a minimum?
There is actuarial and compliance work that is mandated as part of these interest rate changes. Your team at Miller & Newberg is available to assist you with all of this work.
For the valuation rate change, at the very least, we will need to calculate and provide you with new statutory reserve factors to be implemented on your systems by the end of this year (12/31/2020). We will also need to evaluate whether your company provided a demonstration or statement of the reserve method as part of your original product filing with the states or Interstate Compact. If so, informational filings with the appropriate regulatory authorities may be required.
For the nonforfeiture rate change, at the very least, for your traditional life products that were not already using a 4% nonforfeiture interest rate, we will need to calculate new cash value factors to be implemented on your systems by the end of next year (12/31/2021). Since policy forms routinely include statements about and/or tables of minimum cash value figures, we must make the necessary changes to policy forms and file them with the appropriate regulatory authorities.
What impact will this have on my company’s products and profitability, and thus what else should my company consider?
Beyond what your company is required to do by regulation, consider that this means that low interest rates are now having a triple negative impact on your product profitability:
- Lower investment earnings than your product pricing anticipated,
- A requirement of higher statutory reserves, and
- A requirement of higher cash values.
Also consider that these rate changes may create some effects that you desire to avoid, such as:
- Deficiency reserves, and
- Cash values on your term products.
Also, while your company can make the valuation changes on 1/1/2021 and delay the cash value changes until 1/1/2022, there are reasons that you can choose to make the cash value changes earlier, even as soon as 1/1/2021 to correspond with the reserve changes.
Therefore, we recommend an analysis of each of your products to determine if other adjustments to premiums or features are necessary to allow your products to continue to provide the margins necessary for your business. Together, we can put together a game plan to make this change happen as smoothly as possible.