October 2011

Interest rates are low?
Time to review your life insurance coverage.

Interest rates are low?
Time to review your life insurance coverage.

Chronically low interest rates have a number of consequences. Some are positive. Others, not so much.

If you bought your first house in recent years, you will be able to appreciate the beneficial effects of an economic climate where interest rates are in the basement. As the following graphs show, real estate hasn’t been this accessible for 30 years, and on the whole, rarely has the cost of borrowing been so low.

But this situation isn’t all good, notably because it is symptomatic of an economy that has run out of steam. And also because it can make some products substantially more expensive.

By the way, have you thought about your life insurance lately?

A history and future of lower returns

After watching interest rates decline almost steadily for more than 10 years, economists are increasingly starting to toss around the idea of an “era” of low interest rates. Whether or not this era becomes a reality, the fact remains that investors who put their assets in interest-bearing securities, generally considered safer and more predictable than equities, haven’t seen their return outlook improve in the past decade. You’re thinking of pensioners? Think about your life insurance portfolio, too.

In fact, low interest rates could have a dual impact on your life insurance.

  • An imminent increase in premiums for permanent life insurance policies
    In other words, it could cost you more for the same amount of life insurance coverage. That’s because insurance companies are among the investors who rely on the fixed-income market:  they invest the premiums collected from their insureds largely in fixed-income securities, and it is partially the returns generated by these investments that enable them to honour their commitments when it’s time to pay out insurance benefits. If their returns don’t live up to the assumptions they used to set the rates for their products, they have to make sure that future contracts take this new economic environment into account, and thus apply premium increases that, in the present case, are likely to be substantial. In short, while the insurance contracts that you already hold are sheltered from an increase, any that you might need in the future will quite probably be much more costly.

  • A probable increase in your life insurance needs
    In other words, the amount of life insurance that you have purchased in the past might not be sufficient to cover the needs of your survivors by the time of your death. Why? Because the same prevailing low returns will also reduce the capacity of your death benefit to produce the income your family will need. No doubt the calculations that you made with your financial services professional when you bought your policy were also based on anticipated returns that the fixed-income market is no longer able to provide. So you, too, have to compensate – by increasing the amount of insurance you carry.

The challenge:  liquid assets for your estate

This situation brings us back to the basic purpose of life insurance, which is to provide liquid assets for the heirs after the death of the insured. Don’t forget that when you die you will be presumed, for income tax purposes, to have disposed of all your possessions, and that all your gains will immediately become taxable. Of course, this “fatal moment” will be delayed if your spouse survives you, since your assets can be rolled over to your spouse tax free. But this is only a postponement:  sooner or later, the day will come when the taxman claims his share (up to 50%!) of your assets:  RRSP, RRIF, unregistered investments, secondary residence and all the rest.

Let’s suppose, for example, that you own a chalet or cottage that you want to leave to your children because they grew up there and are very fond of it. If it turned out that your estate didn’t include enough cash to pay the taxes on this secondary residence – plus all the new charges that will fall to your children in the future –, your heirs might be forced to sell this precious family property against their will. Life insurance coverage can serve to provide this cash – providing, of course, that it was carefully set up and the amount is sufficient.

It’s not too late

So it’s high time to get in touch with your financial services professional to review your life insurance portfolio given this new era of low interest rates we have apparently entered. Because if you discover that your needs involve permanent life insurance, you should act quickly to secure your premium at a rate that we probably won’t see again any time soon. It’s not too late!