CAA 2021 Gives Life Insurers Interest Rate Flexibility

The big new federal spending package will change the math inside U.S. life insurance policies.

The change will slash a key interest rate used in creating life insurance policies to 2% for 2021, from 4% today, and to a variable rate after 2021.

The rate change will increase reserve levels and cash value levels for new life policies, according to Griffith, Ballard & Company.

Resources

The CAA 2021/H.R. 133 Congress.gov page is available here.
The CAA 2021/H.R. 133 Congress.gov page is available here.
An earlier article about the CAA 2021/H.R. 133 life insurance interest rate provision are available here.

Griffith, Ballard actuaries have analyzed the new federal interest rate rules in a commentary posted on the firm’s website.

Section 7702 Primer

Back in the 1970s and 1980s, some members of Congress thought that wealthy people were accumulating too much cash value in investment funds that were thinly disguised as life insurance policies. In 1984, Congress added Section 7702 to the Internal Revenue Code. IRC Section 7702 includes a cash value accumulation test provision and a guideline premium limitation provision.

To qualify for the federal income tax breaks to go to life insurance policies, an arrangement must pass either the Section 7702 cash value accumulation test or comply with the Section 7702 guideline premium limitation provision rules.

The cash value accumulation test has been based on a 4% fixed interest rate benchmark.

Insurers have used a 6% fixed interest rate benchmark to apply the guideline premium test.

Life insurers have been asking Congress to change the fixed interest rate benchmarks, to reflect the fact that rates on high-grade corporate bonds and other investments in typical life insurance company portfolios are much lower today than they were in 1984.

The New Legislation

Drafters of a COVID-19 response bill — H.R. 6800, the “Health And Economic Recovery Omnibus Emergency Solutions (Heroes) Act” bill — put a Section 7702 interest rate change provision in Section 40308 of that bill.

Drafters added the provision to the Heroes Act bill “to reflect the interest rate environment that has been exacerbated by the current crisis, and ensures that the rates will continue to appropriately reflect economic conditions,” according to a section-by-section summary released by bill supporters.

Cash Value Accumulation v. Nonforfeiture Values

IRC Section 7702 has imposed what amounts to a cap on how much cash value a life insurance policy can accumulate.

The life insurance policy nonforfeiture rules developed by the National Association Insurance Commissioners (NAIC) set a floor on policy values, by establishing standards for how much cash customers who drop their policies should get back. The NAIC has set its nonforfeiture interest floor at 4% to match the 4% floor in the federal government’s Section 7702 cash value accumulation test.

The NAIC recently made 0.15% the new minimum nonforfeiture interest rate floor for individual deferred annuities.

Members of the Life Insurance Actuarial Task Force have been talking about changing the NAIC’s 4% nonforfeiture interest floor for life insurance.

Representatives from the American Council of Life Insurers said that, if the Heroes Act interest rate rules took effect, the NAIC should consider replacing the fixed 4% interest rate floor for life insurance with an indexed rate that would vary along with the Section 7702 interest rate benchmarks, according to draft meeting minutes, from May 21, that were included in a document packet for the NAIC’s summer national meeting.

Representatives from some life insurers said they were afraid that decreasing the nonforfeiture rate floor, and increasing policy cash values, would make basic life insurance protection policies too expensive.