This could be good news for everyone who owns a universal life (or whole life) insurance policy. While universal life and whole life are similar in many ways, universal life is more transparent, as illustrated in Figure 1. The greater the “cash value,” the less the “amount at risk,” resulting in a lower premium in later years. Conversely, the lower the cash value and the higher the amount at risk, the greater the premium in later years to keep the policy in force to age 100.
Assume a $1 million death benefit is desired to last until age 100. A 35-year-old would have to pay approximately $4,000 annually to age 100 if the account value (“cash value”) earned 6.0% each year. If the account value grew by more than 6.0%, the premiums could be suspended before age 100. However, if interest rates grew by less than 6.0%, the policy would lapse before the insured attained age 100 (or premiums would need to be increased to prevent a lapse).
Insurance companies are highly regulated, so their general investment portfolio asset allocations are relatively similar. A sample general portfolio of a major insurance company is illustrated in Figure 2.
As you can see, investment-grade bonds make up 75% of the investments. This conservative mix is necessary to meet liquidity needs in the event of the policyholder’s death, or if the policy is surrendered.
Unfortunately, for owners of universal life (and whole life) policies, corporate bond yields have been on a downward trend since 1984 (see Figure 3).
There is a strong correlation between the typical insurance company portfolio yield and the Moody’s AAA five-year rolling average over time. Insurance company portfolio yields were in the 12% – 13% range in the mid-1980s, similar to the Moody’s five-year rolling average. Today, they are in the 4% – 5% range.
It is this drop in insurance company portfolio yields that has caused so many universal life (and whole life) policies to perform below original projections. Many financial experts believe this 30-year downward trend may finally be close to bottoming out. They believe an increase in the federal funds rate could result in increases in corporate bond rates. Even if this happens, it will take time (see Figure 4).
As previously noted, there is a strong correlation between Moody’s Corporate Bond Yield and the insurance company crediting rates. The chart in Figure 4 assumes a rather aggressive increase in bond yields. It also assumes that new money corporate bond rates increase by 100 basis points in each of the next two years, then retain the higher level for the next five years.
Even with the increase in new money rates, there will be a lag in the overall return of the portfolio. In fact, in this hypothetical, it will take nearly three years for the portfolio to exceed this year’s level.
While the Federal Reserves’ decision to raise rates may bode well in the future for policyholders of universal life (or whole life) policies, caution is encouraged. Insurance company crediting rates will likely continue to drop in the next few years, so it will be important to continually monitor policy performance and fund premiums accordingly. Although there may be reason for optimism, it is more important than ever to regularly review the performance of your policies. We encourage you to contact the life insurance experts at SilverStone Group for a comprehensive review of your insurance portfolio.
This article originally appeared in the 2016 | ISSUE TWO of the SilverLink magazine under the title “What Goes Down Must Come Up, Or Does It?” To receive a complimentary subscription to the SilverLink magazine, sign up here.