With the Federal Reserve reiterating it will keep interest rates at a historical low due to the economic crisis created by COVID-19, a key provision in the bipartisan COVID relief package passed in December deserves mention.
The provision will help ensure the most popular and traditional form of financial protection remains available for families and small business owners. Permanent life insurance provides Americans, primarily middle-income consumers, lifetime financial protection through a policy’s cash value that can keep premiums reasonable for consumers over their lifetime.
To keep this protection viable going forward, Congress updated section 7702 of the tax code to reflect today’s low interest rates.
When enacted in 1984, the code assumed that life insurance companies would earn at least 4 percent on premiums paid into a policy. When interest rates were double digits, that was a reasonable assumption. That is no longer the case.
Insurance companies were already finding it increasingly difficult to find conservative investments, which are required by state law, that return the tax codes’ prior benchmark interest rates. COVID’s impact on interest rates pushed this problem to the breaking point.
An overwhelming majority in Congress wisely altered the outdated, hard-coded rate requirements to reflect the COVID-19 environment. Going forward, in a low interest rate environment like today, the rate in the code will adjust as market interest rates move. This may result in a larger portion of a new policyholder’s premium payment being treated as policy cash value in the early years of a policy to make up for the lower amounts of interest credited over the policy’s life. When interest rates rise and, in kind, the credited rates on new policies rise, the amount of premiums a policyholder would be allowed to save as cash value to cover future premiums in the policy would drop. Section 7702 places limits on policy cash values and premiums in addition to other limits in federal law so that life insurance will never be an investment product like a mutual fund.
Permanent life insurance is an important safety net for families and small businesses. The sensible update by Congress helps ensure this kind of financial security remains affordable and accessible, regardless of economic conditions.
Paul Graham was Senior Vice President, Policy Development at the American Council of Life Insurers (ACLI). Graham was responsible for many legislative and regulatory issues, including all matters accounting and actuarial related. He also was responsible for policy issues relating to annuities, disability insurance, and long-term care insurance.
