Impact of Interest Rates on Life Insurance Products

• Premiums as low as Rs.17/day for sum assured of Rs.1 crore*
• Claim up to Rs. 1,50,000 deduction under section 80C**
• Choose between annual and monthly premium payment options

Interest rates play a huge role in the net assets and liabilities of all major firms. This is applicable for insurance companies too. Almost all major insurers in the market invest their revenues in different securities to get returns. Most life insurance companies invest in stocks and bonds to generate capital gains for their customers. These investments are also critical to the profitability of these companies. Any changes in interest rates could significantly affect the profitability of these firms. This, in turn, will also affect the returns generated by their customers.

Interest Rate Risk

Any risk arising from the fluctuating interest rates is known as interest rate risk. Most insurance companies in India have investments in interest-sensitive assets in the market. Low yields from various assets are likely to have a negative impact on the company. While short-term fluctuations are unavoidable in most cases, a considerable decline in long-term proceeds will adversely impact a company. Many companies have built-in provisions within their major products to protect themselves from interest rate risks.

Impact on Term Covers

A term insurance policy is a pure insurance plan that offers high-value coverage against the death of the policyholder. One of the factors to be noted here is that the cost of term insurance plans does not change once entered. For instance, if buy a term cover for Rs.1 crore at the age of 25 years for a yearly premium of Rs.5,000, the price will remain the same throughout the policy term as long as the premiums are paid on time.  This is the reason why most industry experts encourage individuals to purchase a term plan at a young age.

Among the various factors that influence the cost of term insurance policies, interest rate is a significant one. However, this is applicable only for the initial price of a term cover. Since there are no maturity proceeds, a company’s liabilities do not change with regard to term insurance covers. The impact of interest rate risk is extremely low for customers who have term plans. Most of the top insurers in the market have built-in provisions for interest rate risk within their term plans. If there is a drastic decline in interest rates, the company may hike the premiums for future customers.

Impact on Traditional Life Insurance Covers

Traditional life insurance covers typically include whole life insurance plans and endowment plans. When the interest rates are lowered, the impact is typically passed on to customers in the case of traditional life insurance products. Hence, any significant decline in interest rates will also reduce the insurer’s liabilities to customers. Though it might seem that insurers are protected from interest rate fluctuations, they suffer by way of lower sales and revenues that follow interest rate cuts.

If a product generates lower returns due to decline in interest rates, it becomes less attractive to policyholders. Due to lower sales and revenues, insurers might face shortage of money to invest. This could bring down the overall yield and have an adverse impact on the earnings of an insurance company. Decline in net yields could also make it challenging for a company to pay the compensation for non-participating endowment plans that have guaranteed returns. In this scenario, insurers look for ways to generate additional income through premiums. Since the Insurance Regulatory and Development Authority of India (IRDAI) does not allow insurers to increase premiums whenever they want, the company might withdraw the product completely and introduce a new product with higher premiums and lower guaranteed returns.

Impact of Interest Rates on ULIPs

Unit-linked investment plans (ULIPs) are a form of life insurance that provide returns through the investments from the market. Here, customers are free to choose the types of funds based on their risk profile. Most investors choose a combination of debt and equity investments to balance their risk. When interest rates increase, customers prefer risk-free investments like debt funds and government bonds since the yields are likely to go up. Also, the general rule of the market is that equity valuations are likely to come down when interest rates in the country go up. Hence, the impact could be a little mixed when it comes to ULIPs.

Ultimately, it comes down to the investor’s choice in mutual funds. Investors should study the impact of interest rates on various levels before picking the right investment securities. Risk-averse investors could incline towards debt funds and generate moderate returns from their investments. Those with a higher risk appetite could incline towards equity funds and aim for aggressive growth.

Conclusion

Any fluctuation in interest rates is likely to have a significant impact on life insurance companies in the market. Insurance companies typically have provisions to overcome interest rate risks. If the risks are unbearable, they may do away with a specific product altogether and introduce a new one with minimal risk. Considering all these factors, the prevailing interest rate will have a major influence on a company’s investments, product mix, profitability, etc.