COVID-19 has changed many aspects of our lives, so it isn’t surprising to see life insurance markets affected. But some stories create false impressions that should be corrected.
The story that some life insurers are writing fewer policies “because of COVID-19” has gained traction in both traditional and social media. While not wrong, like other stories involving insurance and COVID-19, it requires context to keep it from wandering off into urban legend territory.
“Life insurers’ ability to keep their promises to policyholders depends on numerous factors,” explains Triple-I chief economist Dr. Steven Weisbart. “Among them are interest rates and how responsibly insurers underwrite policies and manage their investments.”
Interest rates exceptionally low
What do interest rates have to do with life insurance? Many products (whole and universal life and term life for 20 years or more) calculate premiums in the expectation that, during the life of the policy, the insurer will earn enough interest from its investments, net of investment expenses and taxes, to help pay life insurance benefits. Many life insurance and annuity policies – especially those issued 10 or more years ago – guarantee to credit at least 3 percent per year.
“Efforts to stave off the recession spurred by attempts to ‘flatten the curve’ of infections and deaths caused by the virus have led to historically low interest rates,” Weisbart says.
Gross long-term rates on the investment-grade corporate bonds life insurers primarily invest in had been 4 percent for most of the past decade and plunged below 3 percent in August 2019. Since the onset of the pandemic, rates have fallen even further (see chart).
“So, life insurers – who planned to profit from the ‘spread’ between the interest they earned on their investments and the interest they credited on their policies – have lately struggled as this spread disappeared and then reversed,” Weisbart says.
Options are limited
“So, that’s it!” I hear some of you say. “It’s all about rich insurance companies protecting their profits!”
Businesses must make a profit to stay alive, and U.S. insurers – one of the most heavily regulated and closely scrutinized businesses on the planet – have the additional requirement to maintain substantial policyholder surplus to ensure claims can be paid. Life insurers, in particular, are required to maintain a special account – the interest maintenance reserve (IMR).
“The IMR is drawn down when net interest earnings are too low to support claims – as is the case now,” Weisbart says. “If it’s exhausted, insurers can draw down surplus, but they can’t draw too much because they’re required to keep at least a minimum surplus to protect against adverse outcomes in all other lines of business.”
If their investments aren’t performing as well as expected, insurers have two options: write less business or charge more for the business they write.
Exercising a combination of these options is what life insurers are doing now.
“When interest rates eventually rise, the profitable spread will return,” Weisbart says, and competition among insurers will likely lead to more liberal underwriting and lower premiums. “But we can’t predict with confidence when that might happen.”
Until then, life insurers are tightening their criteria for issuing new policies and, in some cases, raising premiums so they can deliver what they’ve promised their existing policyholders.