The Consolidated Appropriations Act – A Win For Permanent Life Insurers
Most life insurers have redesigned their permanent life insurance products due to the new calculations introduced via the Consolidated Appropriations Act, 2021 (H.R. 133). While the Act was mainly about spending and the stimulus check, it also included a provision that changed how the minimum interest rate used in specific life insurance contracts is calculated. This led to the determination of a new rate for the first time since 1984.
The Moody’s Investors Service sees this as a credit positive for insurance companies, as they’ll experience an increase in permanent life insurance product sales because of the new calculations.
The CAA provision lowers the minimum rates used in determining whether a permanent life insurance product meets the requirements under the IRS Code section 7702 to qualify for tax treatment as insurance instead of an investment.
Lowering the rates would result in a higher cash value relative to the death benefit. It would also allow policyholders to put more money into it without triggering modified endowment contract status, which would attract adverse tax consequences.
As stated in Section 7702, for a contract to qualify as a life insurance policy contract for federal income tax purposes, it must be a life insurance contract under applicable law and must satisfy either of the following:
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The cash value accumulation test.
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The guideline premium and corridor test (which limits the amount of premium that one can pay to a life insurance relative to the policy’s death benefit).
Mutual Insurance Benefits
However, the new rates are only applicable to life insurance contracts issued from Dec. 31, 2020. For contracts issued in 2021, the initial interest rates would be set at 2% and will adjust prospectively with the market rate.
The new calculations for life insurance policies would enable insurers to offer more flexible pricing in the current low-rate environment. The calculation is mostly favorable to mutual life insurance firms that sell life insurance products. Before the CAA resulted in a change in section 7702, whole life insurance policies needed a 4% minimum guarantee to avoid triggering the MEC status upon making premium payments.
Mutual life insurers faced high pressure to provide guarantees as market rates plummeted over the past decade, especially last year. Further decline in rates would have placed insurers in a difficult position where they’ll need to provide a guarantee above the rates that they can earn on fixed income securities.
With the new law, the guarantees are reduced from 4% to 2% in 2021, which will give mutual insurers the flexibility to sell life insurance products even in low-interest environments. It also allows for more flexibility in product design.
Modest Credit Positive for Universal Life Writers
Insurance firms that sell accumulation-focused (as against death benefit-focused) permanent life insurance like universal life insurance, variable universal life, and indexed universal life would benefit from the new regulations. Policyholders would be able to put more dollars in premiums to their death benefits without triggering the MEC and attracting high taxes.
Implementation Concerns
While some of these options are already being implemented, most would require some time for life insurance firms to reevaluate their product offerings. Many insurance companies would need to review their product pricing and obtain necessary regulatory approvals. Insurers would also need to update their systems. So not every company would be in a position to implement the new regulations immediately.
The regulations may also have some unintended consequences, one being the impact on agent compensation. Agents are paid a specified percentage based on the target premium. Assuming a consumer must pay a fixed amount into their policy, the new regulation can lower the required death benefit needed to retain the policy. The low death benefit would lead to a lower target premium and ultimately reduce the commission.
Additionally, there are several price discounts insurers give for bands of more significant face insurance amounts. A lower death benefit would result in lower lead and lower costs of insurance. Moreover, if the policy crosses over to the lower threshold without being given preferential treatment, it could increase COI charges.
