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Why life insurance premiums are rising
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The Toronto Star- When I bought my first insurance policy three years ago, I wanted it to do three things: Pay off my house; cover other expenses for family, and not cost myself hundreds a month in premium payments.
So I found a cheap policy for an amount my family could live with if I died, and I signed on the dotted line.
I didn’t find out what determined my rate, and my broker didn’t tell me.
If I had asked, I would have found out that, because of falling interest rates, my new policy was more expensive than it would have been if I bought it before the recession.
Life insurers invest premiums in the bond market and, when bond returns fall, the amount available to pay benefits declines and premiums may rise to compensate.
Life insurance premiums are calculated based on three factors, says Helena Smeenk Pritchard, a former insurance manager who now teaches financial professionals how to sell and discuss life insurance.
These are mortality, interest rates and company expenses.
Mortality covers health and age and has the biggest effect on premiums, but interest rates also have a significant impact on how much new policyholders pay, Smeenk Pritchard says.
The cost of insurance rises as people get closer to death, but payments are the same from month to month. So, technically, you’re paying more for insurance when you’re healthier, and less as you age.
As it’s unlikely your policy will be paid out when you’re young, those premiums are invested mostly mostly in fixed income products such as bonds and mortgages.
Insurance companies invest your money so they’ll have enough dough to pay out when you die and to make profits for shareholders.
As interest rates drop — they’ve fallen about 3.25 per cent since 2008 — insurers make less money on their investments, so premiums have to rise to make up the difference.
“It’s like saving for retirement,” says Paul Fryer, vice-president of individual insurance for Sun Life Financial Canada. “If you want to have a certain sized nest egg for retirement, you need to save a certain amount each year. The investments will be higher if you’re investing in a lower-interest-rate environment. The same thing happens here.”
Rates, he says, increased by about 10 per cent in the first half of the year. While companies have lowered their own costs to postpone raising premiums, the low interest rate environment, he says, “has really caught up with industry and has caused the cost for people buying new insurance to rise.”
Not all products are affected by rate changes as much as others.
Short-term policies, such as term 10 insurance, which only lasts for a decade, doesn’t span enough time for rates to make a big difference.
It’s term 100 insurance, which covers you until you turn 100, and whole and universal life polices — plans that cover you until death —that are most affected.
Longer-term products are more sensitive to interest-rate movements, because the premiums, which are set at the beginning of the policy and don’t change, have to cover a lifetime’s worth of rate changes. Actuaries make assumptions on what the rate will be over the years, and, if that assumption is incorrect, prices on new policies will have to change.
Steve Easson, vice-president and chief actuary for the Canadian Life and Health Insurance Association, explains that companies take a pool of policyholders, say 999 Canadians each taking out a $1-million policy, and then determine how many policies they’ll have to pay out in one year.
If they assume one out of every 1,000 policies will be paid out in a year, the company has to make sure it has enough money — $1 million — to cover the payout.
If investment returns are 10 per cent, companies would need to charge clients $900,000 a year, collectively. If the interest rate is just 1 per cent, policyholders would be charged $999,999.
“The lower the interest rate, the higher the premium,” he says.
Monthly payments on existing policies won’t change, but products such as participating whole life or universal life policies, where people receive dividends, could be affected when rates rise and fall.
Fryer says products with an investment component — on some products the premium is invested by the policyholders and on others by the insurance company — usually pay dividends when the company makes profits. If rates are low, the company makes less money, which means dividend payouts will decrease.
“As interest rates have come down, dividends have gone down,” he says.
With rates near all time lows, most people expect them to increase.
When that happens, says Fryer, new premium rates could come down, while dividends may rise.
While rates are having an impact on premiums, it’s unlikely the general public will ever know. Smeenk Pritchard says that most brokers only want to sell the lowest priced policy and don’t know how to talk to the public about what they’re paying and why they’re paying it.
Ultimately, consumers don’t have an option. You could wait until rates rise and hope premiums drop, but it’s anyone’s guess as to when interest rates will increase and if insurance companies will even lower payments when they do.
For me, interest rates wouldn’t have made a difference; I needed to be insured to protect my family. And that’s the thinking of most new insurance buyers, says Smeenk Pritchard. “I don’t think people are interested in how insurance is priced.”
That doesn’t mean people shouldn’t ask. Although you may not get a good answer, if you do. “Generally speaking, brokers don’t get into the weeds,” she says. “Unless they’ve been around the block a number of times.”
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