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All About The Variable Loan Rate

Variable loan interest rates on a life insurance policy are very common today.

Some hear the term “variable” and hesitate at moving forward due to the lack of control. In general, products with variable loans can result in a consumer’s paying more in interest because an institution decides to increase the rate.  The question is:  How do variable loan rates function with life insurance companies/policies?  Let’s break it down:

  • Question: How “variable”  IS the loan rate, and how often can it adjust?
  • Answer: If we own a life insurance policy with a variable loan rate, the loan rate can only adjust 1x per year. This adjustment will occur on our policy anniversary date; this is our premium due date.
  • A variable loan interest rate can adjust dailyfor the life insurance company.
  • A variable loan interest rate can adjust only 1x per year for the policyholder.
  • Question: Is there a floor on how low the loan interest rate can be?
  • Answer: Yes. Most insurance companies set a floor of 4.5% – 5%.  This is often documented in our formal insurance contract.
  • Question: Is there a cap on how high the loan rate can increase?
  • Answer: No, but we do have some protection in the event interest rates skyrocket.
  • No cap exists on how high the variable loan rate can climb. For example, in the 1980’s dividend rates were between 12% and 13% with insurance companies.  At the same time, variable loan interest rates on policies were around 11-13%.
  • We do have protection on how much a loan interest rate can increase per year. Many companies will build in protection for policyholders by capping the annual increase of a variable loan rate. The annual cap increase is usually 0.50%

For example:

  • Life insurance policy is established in 2020 with a 5% loan rate.
  • The insurance company and policyholder each have a rate of 5%.
  • Interest rates skyrocket, and the insurance company has a loan rate of 10% in 2021.
  • The policyholder will experience a 0.50% increase and carry a loan rate of 5.50% loan interest rate in 2021.
  • If loan rates drop, there is no restriction of how much the loan interest rate can drop, except for the company’s floor (this is usually 4.5-5%).
  • Question: How does the company determine the loan rate, and can they increase it at their discretion or because they feel like it?
  • Answer: Most insurance companies will tie their variable loan rate to an AAA Corporate Bond Index. A common gauge is Moody’s Corporate Bond Index Average.
  • Moody’s Corporate Bond Index Average rate adjusts daily and has been below 5% for several years.
  • If the Bond Index Average was above 5%, the insurance company’s variable loan rate would adjust daily, as well.
  • Keep in mind that the policyholder will only experience an adjustment 1x per year, not daily. For example, if an insurance company’s interest rate was 5.2% today, all policies issued today would have a 5.2% rate for 1 year, which can be adjusted on the anniversary date. If the insurance company’s rate was 5.25% tomorrow, all policies issued would have a 5.25% loan rate for 1 year, which can be adjusted on the anniversary date.  The rate may adjust on the policy anniversary date.
  • Question: Are policies with a variable loan interest rate non-direct recognition?
  • Answer: Yes, in most cases.  In the event loan interest rates rise, dividends will likely increase as well. A Non-Direct Recognition Policy is always going to credit the same dividend on any funds in cash value and any loaned dollars. Historically, and presently, dividend rates and variable loan rates have always moved up/down together.

This article covered a lot of details. It is important to look at the specific insurance contract and company we are using. This will allow us to review the actual terms and understand exactly how our policy, or the policy we are considering, will function.

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