What Happened in 2021?

What Happened in 2021?

By Tom Wall, Ph.D., MBA, MSFS, CLU, ChFC

Now is the best time in over 80 years to own whole life insurance for predictable cash accumulation purposes, relative to other alternatives such as bonds.  While the death benefit should be the primary focus and ultimately what creates the most value for clients, there are two main reasons I share this opinion about cash accumulation.

The first has to do with interest rates.  In 1981, interest rates hit their all-time high as the Fed flexed its inflation-fighting muscles.  This kicked off the biggest bull market in history, because as rates continuously fell for the subsequent 40 years, bonds thrived.  Bonds thrive in declining rate environments because the value of older, higher-yielding issues appreciate in value relative to new issues with lower coupon payments.  Investors will gladly pay you a premium for your higher-yielding bonds in that environment, which is what caused bond funds to generate nice returns.  This almost certainly can't be repeated when starting with rates as low as they are now.

Mutual life insurance companies routinely invest in long-term corporate bonds, capturing the highest yields possible which tend to be offered at the long end of the yield curve.  Furthermore, this more closely matches their ultimate liability which is the permanent death benefit they're guaranteeing will be paid WHEN you die (presumably several decades from now), not IF you die such as with term insurance.  They’re not worried too much about the liquidity of those investments because of their strong capital inflows from renewal premiums, coupled with their massive surplus capital positions.  You can think of this surplus as cash on hand to weather financial storms or be opportunistic with investment opportunities.

So, in low-for-long rate environments, the dividend interest rate represents somewhat of a rolling average of what the long-end of the yield curve has been offering over the last 10-15 years or so.  I’m obviously generalizing quite a bit, but that’s the idea.  In rising yield environments like we saw in the 60s and 70s, bonds suffered due to the inverse relationship between rates and bond prices.  In that era, returns were rather paltry, with double the volatility we experienced over the last two generations since the early 80’s.  However, as rates rose and brought up the portfolio average yield of the big mutuals, dividend interest rates increased as well, albeit with a lag.  Going forward, if looking at a long time horizon as we do in financial planning (we’re typically not acting as traders), low-for-long or rising rates are the only two distinct possibilities, even though rates could fall again in the short term and create a good year or two for bonds. Participating whole life insurance should capture that upside as it has in the past.

In 2021, insurance companies were able to reprice their whole life products based on a guaranteed rate between 2% and 3.75%.  Since the mid-1980s, they were required to use a minimum guaranteed rate of 4%, which was viewed as potentially unsustainable at a time when long-term corporate bonds were offering between 2.5% and 3.5%.  Congress changed the rules to allow companies to offer lower sustainable guarantees, which resulted in the IRS 7-Pay test being re-calculated.  In the eyes of the IRS, if insurance companies were making guarantees at half the rate they were before, then it was reasonable to assume they should be able to collect as much as double the premium in some cases for a given death benefit without triggering MEC status.  The result was over-funded, short-pay policies that generated early cash values more efficiently because there was less mortality cost due to lower face amounts relative to the premiums being paid.

We are in the best environment to own whole life insurance for cash accumulation in over 80 years. Not because rates are high - they are still historically low.  But relative to other fixed-income instruments and tax-advantaged accounts with strict rules attached, whole life offers predictable growth and bond-like returns over time, but without the volatility due to contractual guarantees.  As a misunderstood asset, it remains one of the best-kept secrets in personal finance.  Make this your year to have a huge impact and let your clients in on it.