Evergreen in a season of change: How rising interest rates are affecting life protection 

Issue 3, June 2022 | PCS Vision

It’s a little wild out there. Volatility everywhere you look, and after a prolonged period of historic lows, interest rates are rising globally as central banks across the world try and curb the hottest inflation rates in four decades.^[1] Mercer PCS Singapore CEO, Davin Wong, explains the effects of raising interest rates and the changing shape of the USD yield curve on life protection products. He demonstrates why – when it comes to life insurance and legacy planning – high net worth (HNW) and ultra-high new worth (UHNW) individuals can keep their eyes on the long-term goals of their core portfolio and weather volatility. He also outlines the beneficial effects of incorporating life insurance into one’s portfolio despite the changes in the interest rate markets.

Any investment product with a long tenure is sensitive to interest rate movements. In life protection solutions such as Universal Life Insurance (ULI) and Whole of Life Insurance (WoL) – which have a significant investment component – the time value of money impact is amplified in the composite instruments.

Investment components embedded within the policy design supporting life protection solutions, such as ULI and WoL policies, are generally heavily weighted in bonds.^[2] In a rising interest environment, clients will note the yield on existing solutions will rise. This will have the positive impact of reducing the upfront premium payments as the returns derived from the investment components in the policies are "marked" to market.

But beyond yield, the primary objective of protection is in itself important, and life insurance remains a highly effective wealth planning and estate transfer mechanism, unaffected by fluctuating volatility.

We have seen in the past 15 years a period of normal upward sloping yield curve. This has allowed HNW individuals to take advantage of accessing the favorable short-term interest rate in funding a premium to incept a protection life policy.

The changes in the global interest rate markets have also seen the shifting shape of the USD yield curve – it has flattened somewhat. This effectively means that it is less economical for HNW clients to access the short-term loan markets to fund a long term instrument such as a life policy. On the other hand, raising a loan helps HNW clients with the liquidity to implement his/her estate and legacy plan.

An alternative to raise liquidity, which may be considered by HNW clients in the current flat yield curve environment, is to fund the life policy through a multi-pay option offered by the insurance company.

Multi-pay premium financing enables the client to spread the cost of purchasing a life insurance policy over a period of time while locking in the current low interest rates.

A multi-pay option is in effect, a premium loan provided by the insurance company at a competitive fixed-loan rate. The loan is repaid by way of multiple equal instalments – which could be over a number of years – and can be repaid without any early repayment penalty.

A multi pay option can be seen as premium financing provided by the insurance company based on a fixed rate. The client implements a ULI or WoL solution in order to put in place a high value of protection.

In essence, premium financing also improves the client’s liquidity. Effectively, the client would utilize less cash/liquid assets in acquiring long-term protection. When a bank premium loan becomes uneconomical to implement, credit can be provided by the insurance company in the form of a multi-pay option.

The need to think long-term is an especially pertinent one for Northeast Asia, which has three of the top ten UHNW countries. It is where much of the wealth remains in the control of the generation which created it, who are younger, on average, than the HNW individuals of other places such as the United States.^[3]

The transfer of that wealth over the next few decades^[4] requires thinking on a generational timescale as well as careful planning, and as such, it is an evergreen matter.

Evergreen matters ought not to be subject to the short-term volatility and the fluctuations of interest rates. Life protection is a safe, long-term asset class, providing stable liquidity and a proven estate-equalization/wealth transfer tool.

The functionalities that high value protection policies bring to the portfolios of HNW individuals are long term. Changes in the capital markets (including interest rate markets), in the manner described above, will not alter the way HNW individuals can continue to use these functionalities in their estate and legacy plans.

We note also that whilst legacy planning is a long-term proposition, once implemented, annual reviews with life protection consultants are particularly crucial. Life changes, at times dramatically, so it’s important that clients are regularly updated on the performance of their solution, and the solution continues to meet their needs and objectives.