2 Most Common Ways Life Insurers Charge Interest on Policy Loans

Despite the fact that companies may use a variable policy loan interest rate, the majority of companies still use a fixed rate, which is commonly 8 percent, although it varies by company and from one policy type to another. This suggests that many consumers prefer the certainty of a fixed rate. Companies that use a variable rate usually determine that rate using the greater of: (1) Moody’s corporate bond yield for the month ending two months before; or (2) 1 percent plus the rate being credited to cash values. The impression seems to be widely held that the variable rate cannot exceed 8 percent or Moody’s composite yield. However, this is in fact not generally true. There is no absolute limit in most cases except that which may be specifically imposed under state law.

Another apparently widely held misconception is that most companies using variable policy loan rates also generally permit policyowners to elect to use a fixed rate. Only a subset of the companies using variable rates permits policyowners to elect to use a fixed rate instead.

When market interest rates exceed 8 percent, most policyowners feel that fixed rates are more attractive than variable rates. However, companies that use a fixed rate typically also use an offset provision that credits cash values backing policy loans with a lower rate than they currently credit to other cash values. In the case of dividend-paying policies, the dividend-allocation formula typically will take account of loan balances and credit lower dividends to policies with higher loan balances. Consequently, it is not at all clear that the fixed policy loan rate is more economically beneficial than a variable rate.

Given the misconceptions and misunderstandings regarding policy loan rates, offset provisions, and the availability of an election between fixed and variable loan rates, it is important to closely inspect the policy loan interest rate provisions of all policies under consideration.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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