Inflation Affects Life Insurance

Automatic Premium Loan

Whole Life policies offer a provision, the Automatic Premium Loan (APL), to pay premiums using a policy’s cash value in the face of a potential policy lapse.  This provision must be selected by the policy owner to be in effect.  When a premium is due, there is generally a 30-day grace period after the due date to remit the payment.  If the grace period is exceeded and the APL provision is in effect, the carrier will take a loan from the cash value of the policy to pay the premium.  This loan will incur interest, based on the interest rate assessed by the carrier.  This interest rate can be variable and increase when the economy experiences a rise in inflation. 

If there is a loan balance at the insured’s mortality, the loan and accrued interest are deducted from the death benefit that is paid to the policy’s beneficiary.  If the policy is surrendered before the insured’s mortality, the loan and accrued interest will be deducted from the cash value that is paid to the policy’s owner.  If the loan and accrued interest exceeds the cash value in a policy, the carrier will liquidate the policy to re-pay the loan.  In this instance, not only will the death benefit be lost, but the policy owner will receive a Form 1099-R to pay taxes if there was any gain in the policy, even though they did not receive any cash upon liquidation.

For participating policies, dividends might be earned in the policy every year and can be used to increase the guaranteed accumulated cash value at the beginning of the following policy year.  Dividends are not guaranteed and are based on the carrier’s annual experience.  If a carrier excels in a given year, the policy owners of participating policies get a share of any divisible surplus.  In recent years, the dividend rates have been trending downward.  For example, Northwestern Mutual’s dividend rate was 8.60% in 2002 but only 5.00% in 2022.  The 2023 loan interest rate at Northwestern Mutual is 8.00%

Inflation can increase both the dividend rate and the loan interest rate.  If the loan interest rate and the dividend rate are similar, the dividend amount can be used to offset the loan and accrued interest.  However, the loan interest rate can increase much higher than the dividend rate, which can put a policy at risk of lapsing when the loan amount with accrued interest exceeds the cash value.  If the policy owner cannot pay the full loan amount back to the policy, loan interest payments can be paid on top of premium payments to keep the policy going.  Alternatively, a policy with a loan balance can be moved via a 1035 Exchange to a new policy.  The policy owner generally has two options for the 1035 Exchange:  (1) pay the loan balance with the cash value before it is rolled over to the new policy or (2) choose a new policy with a lower loan interest rate and roll the loan over with the cash value.  The pros and cons of each option should be evaluated with a trusted insurance source to help the policy owner make an educated decision.

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