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.”
Triple-I Chief Economist
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.