Due to market interest rates generally declining over the past five years, the maximum valuation interest rate for calculating statutory reserves for life insurance policies will decrease from the current 4.5% annual level for long-term life insurance contracts to 4% for issues in calendar year 2006.
When this change occurs, carriers must then use a 4% or lower interest rate for calculating statutory reserves for long guaranteed duration life policies (such as whole life or universal life).
The maximum statutory valuation interest rate is defined to represent a conservative net investment earnings rate for assets backing policy liabilities.
Although market interest rates have increased recently, leading some to wonder why the maximum statutory valuation interest rate is decreasing now, it is important to remember this: The maximum valuation interest rate is based on a calculation reflecting a historical lag in market interest rates.
This calculation includes one- and three-year past averages of interest rates from Moody’s Corporate Bond Index. These current averages therefore include interest rates that have been declining over the past several years.
What does a decrease in the maximum statutory valuation interest rate mean for carriers and life insurance purchasers? Why should they care?
A decrease in the maximum statutory valuation interest rate could make insurance products more costly for carriers and consumers.
Everything else being equal, lowering the maximum statutory valuation interest rate generally will increase the level of statutory reserves for new life insurance sales and decrease profits.
Carriers should look to their currently issued products and assess the impact that a lower valuation interest rate will have on product profitability.
Some companies already have been assessing the profit impact of the change from the 1980 Commissioners Standard Ordinary mortality table to the 2001 CSO mortality table for reserves and cash values.
With the valuation mortality table change, statutory reserves for a typical universal life plan, for example, may decrease between 0% and 10%, depending on gender, issue age, risk class and duration.
The decrease in the maximum statutory valuation interest rate may offset this decrease in statutory reserves and might even require increased premiums for key segments of new life sales. These increased premiums could make it more difficult for agents to place business.
In addition, if statutory reserves increase, Risk Based Capital levels (an additional capital allocation) may also increase.
The accompanying table illustrates potential premium changes needed to maintain profitability for hypothetical UL and term life plans due to the change in the maximum statutory valuation interest rate to 4% from the current 4.5% level. These figures are based upon deterministic pricing at selected key pricing cells.