Two Most Common Interest Crediting Methods With Single Premium Life Insurance

How the insurance company determines the amount of interest to credit to single premium current assumption policies (and indirectly to ordinary life policies through the dividends) is extremely important. Some policies make this very clear by indexing the policy’s current interest rate to interest rates on third-party money instruments, such as Treasury bills or certain bond indexes. In other cases, insurance companies credit interest to individual policies using one of two distinct methods: (1) “portfolio rates” or (2) “new money” rates.

If the company uses the portfolio method, all nonborrowed values within all contracts receive the same rate, regardless of when the company receives the premium. In other words, all policyowners share equally in the company’s overall portfolio performance, including both old and new investments.

New money methods, in contrast, credit to new premiums an interest rate that reflects current investment conditions. If current market investment rates are higher than previous rates (and therefore, higher than the overall rate on the company’s investment portfolio), cash values attributable to new premiums are credited with higher rates than cash values attributable to previous premiums. Conversely, if market rates are down, new money is credited with a rate that is lower than the company’s overall portfolio rate.

Renewal values receive some form of “aged” portfolio rate depending on how the contracts are grouped. Insurers may group contracts by issue year or by contract type. The insurers account for the assets and liabilities for each group or block of policies separately, with each block thus developing its own portfolio rate.

Because single premium policyowners make just one payment, the trend of market rates will determine whether the portfolio method or the new money method is more favorable. If market rates are historically high, the new money method will give the most favorable performance. In contrast, if market rates are historically low, the portfolio method will be most favorable. Over a decade or more, the initial advantage will vanish and the differences will be small, or perhaps even nonexistent.

In the late 1970’s and early 1980’s, market rates of interest were historically high, and most single premium policies were issued using new money rates and an “aging” formula that gradually shifted to the portfolio method. As interest rates began to fall in the late 1980’s and early 1990’s, the new money rates were not as high and single premium policies using new money rates became less attractive. As a result, some companies shifted to using the portfolio method for new single premium policies to make them more attractive.

Because variable life policy cash values are invested in separate accounts similar to mutual funds, the issue of how the insurer credits interest to cash values is essentially moot. Investment earnings in separate accounts are allocated to all policyowners essentially in proportion to their ownership of the fund in much the same way as earnings are allocated to mutual fund shareholders.

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

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