Will Lower Interest Rates Lower Insurance Premiums?

In general, a low interest rate environment does not directly lower insurance premiums. In fact, rising interest rates are more profitable for all insurers, but especially life insurance companies and the life insurance industry as a whole.

When the Federal Reserve announced a lower benchmark interest rate, consumers hoped their insurance premiums would drop too. Unfortunately, with low market interest rates, insurance rates may actually rise at renewal.

The effect of lower rates on economic growth is a complicated topic, because the answers lie in how market rates affect the investment portfolios of insurance companies. Certain types of policies are also affected more than others, and some companies fare better, with greater investment income due to stronger existing portfolios. In general, however, permanent life insurance products, like variable universal life policies, will see significantly lower returns when interest rates fall.

A rising interest rate environment can positively influence costs for life insurers and policyholders of certain types of permanent life insurance policies, because the cash value growth of policies depends on the federal funds rate, interest earnings and investment returns. Therefore, rising rates are beneficial. This is why life insurance profitability for policyholders soared when key rates spiked not too long ago, due to higher yielding assets.

Let’s dig deeper into each type of insurance, to see how and why the new drop in interest rates may adversely affect your premiums.

How Do Interest Rates Affect Car Insurance?

Lower interest rates won’t have a direct effect on car insurance premiums. However, insurers use your monthly premiums as investments in bonds and fixed-income securities that are greatly affected by interest rates. If insurance companies cease to gain returns on these investments, they may have to raise rates across the board, even for people with a perfect driving record.

How Do Interest Rates Affect Homeowners Insurance and Renters?

The way rates impact homeowners insurance and renters insurance is exactly the same as the way interest rates affect car insurance. When insurers’ investments have a low market value, they lose investment earnings, so they may raise rates across the board, even if you have perfect credit and a well-maintained home in a safe neighborhood. Increases may be slight or steep, depending on the market and the profit margins of your insurance company’s investments.

How Do Interest Rates Affect Health Insurance?

Again, lower rates may have an adverse effect on health insurance premiums for the same reason as car, home and renters insurance are adversely affected: because insurance companies need to maintain profitability from their investments on the market.

How Do Interest Rates Affect Life Insurance

Interest rates have a significant impact on permanent life products, because these types of policies have a cash value component that grows over time, especially when interest rates are high.

Life companies may raise rates when a key interest rate is low because the insurance company’s investments will suffer.

In policies like whole life or universal life, the cash value grows based on the investments made by the life insurance company. When interest rates are high, the cash value grows faster and dividends or interest credits are higher. With low interest rates, policyholders may have to pay higher premiums to keep the policy active.

Here’s more about how interest rates affect each type of insurance.

Interest Rates and Term Life Insurance

Term life insurance is moderately and indirectly affected by a drop in interest rates. If the insurance company yields a smaller return on investments and they need more money to remain profitable, they will raise rates even more than expected on premiums at renewal. Higher yields usually go hand-in-hand with higher interest rates.

Interest Rates and Whole Life Insurance

Traditional whole life premiums stay level for the life of whole life policyholders. However, there is a product called interest-sensitive whole life insurance, which is affected by interest rates. The good news is that your returns may decrease due to market fluctuations but you’ll never lose money on any type of whole life policy, because they have a minimum guaranteed return.

Interest Sensitive Whole Life Insurance

An interest-sensitive whole life insurance policy is more complicated to manage but can be far more profitable than a traditional whole life policy, if managed correctly. However, they perform less well when interest rates are low. Just as with a traditional whole life policy, you’re guaranteed a minimum return.

Most types of interest-sensitive whole life policies perform as well as the insurance company that issues them because the policyholder receives a share of company profits in annual dividends. However, the policyholder does not make any investment decisions.

There is always a greater risk of a policy lapsing with an interest-sensitive whole policy because when profits are down, the policy may fail to pay its own premiums, especially if there are withdrawals or loans taken out against the policy during a low-interest-rate period. However, you’ll never lose money, but your death benefit may decrease.

Excess Interest Whole Life

Excess interest whole life insurance is also interest-sensitive. Your premiums remain level but the cash value will grow more slowly. Conversely, when interest rates go up, the life insurance company credits the interest earnings to the cash value account of the policy.

Current Assumption Whole Life

Current assumption whole life insurance premiums fluctuate each time the insurer re-assesses risk factors. Your premiums may go up or down each year or every few years. There’s a way to work around the cash value losing its ability to pay the policy’s premiums and lapsing: You can deduct the increase from the death benefit. While not ideal, it prevents you from losing coverage altogether.

Single Premium Whole Life

With a single-premium life (SPL) insurance policy, you will be charged a single up-front premium payment to fully fund the policy. You have to have lots of money on hand to buy this type of policy, but that cash value will continue to grow tax-free. The death benefit grows over time also both are sensitive to market interest rates as a result. The higher rates are, the more the death benefit will grow.

SPLs also provide a living benefit, so if you’re suddenly ill or need long-term care, you can tap the death benefit. While doing so may reduce the benefits paid out to beneficiaries in the long run, it’s a great option for those who cannot otherwise afford the health care costs that are not covered by Medicare Advantage, original Medicare or Medicare Supplements.

There are two types of SPLs and each one reacts differently to interest rates:

• Single-premium whole life insurance has a fixed interest rate, which will not fluctuate.
• Single-premium variable life insurance allows policy owners to create their own stock, bond and money market accounts, as well as a fixed account. Interest rates will vary according to the market, greatly affecting these policies and how well your investment portfolios perform.

Fixed Premium Universal Life Insurance

The cash account in a fixed-premium universal life insurance policy is also sensitive to market interest rates. You cannot adjust the premiums, which are fixed, but you can make changes to the death benefit, making fixed premium universal life policies more like an interest-sensitive whole life policy than a traditional universal life insurance policy.

The cash accounts of a fixed-premium universal life insurance policy will also be affected by interest rates. They will perform better when rates are high.

Guaranteed Life Insurance

Guaranteed life insurance policies are whole life policies granted without a medical exam or a series of questions about your health and the medications you take. They come with waiting periods, during which the beneficiary will not get paid the full amount of the death benefit if you die. Premiums on guaranteed life insurance policies are very expensive.

Guaranteed life insurance policies are affected by interest rates. Your policy will grow more slowly as rates drop. A prolonged period of low market rates can be disastrous for your cash value.

People who buy these are between 50 and 80 years old, otherwise. If they are younger, it makes more sense to buy a less expensive whole life policy. Guaranteed life insurance is also not guaranteed. Some conditions that pose a credit risk are the following exclusions:

• If you have a terminal illness with a life expectancy of less than two years.
• If you need an organ or a tissue transplant.
• If you are on dialysis.
• If you have Alzheimer’s disease or dementia.
• If you are in a nursing home or in hospice.
• If you have cancer (basal cell or squamous cell skin cancer do not disqualify you).
• If you have HIV/AIDS.
• If you are wheelchair bound due to health reasons.

Indexed Universal Life Insurance

Indexed universal life policies are greatly affected by a change in rates because they grow according to the investments made by the life insurance company. High market interest rates are preferred for optimal growth. There is, however, a rate guarantee with these policies, so you don’t have to worry about a complete loss: Both losses and earnings are capped.

You are free to change the premiums and the death benefit whenever you like. The cash component of the policy is invested, though not by your choices. You can take out loans against the cash but if you don’t pay it back, it’ll be deducted from the death benefit.

Variable Life Insurance

The cash value component of variable life insurance policies is affected by interest rates because the cash value is invested into a stock market fund. You get to choose which funds to invest in. Like other types of permanent life insurance products, your cash value will continue to grow, slowly or fast, depending on the growth of the choices made in investment portfolios and the interest rate, which varies over time.

You can borrow or withdraw from the cash component, and your policy will remain active as long as premiums are paid. If you withdraw a cash amount below the basis, that amount will be subtracted from the benefit that goes to your designated beneficiary or beneficiaries. The same is true if you take out a loan and do not repay it.