TAX LAW
Closer look :
7702 ’ s new impact on product pricing
Insurers will have added flexibility , but how will consumers respond when the changes potentially mean a higher cash outlay ?
Steve Parrish , JD , RICP , ChFC , CLU , AEP is Co-Director of the Retirement Income Center and Adjunct Professor of Advanced Planning at the American College of Financial Services . He is a contributor to Forbes . com and Associate Editor of the Journal of Financial Service Professionals .
36 Perspectives Q2 2021
During a time of election fall-out , the pandemic , and the holiday season , many life insurance advisors may have missed an important tax provision buried in a late 2020 law . The Consolidated Appropriations Act changed the minimum statutory interest rate assumptions used to calculate premium funding limits under IRC Section 7702 (“ 7702 ”). The bottom line is that now rates for new policies are no longer fixed once a policy is in-force ; in fact , they can change as often as once a year .
Cash-value product reluctance
Section 7702 was created in the mid-1980s to assure that life insurance policies would not be used as a tax shelter . The provision created maximum premium calculations based on a then-conservative rate of 4 % for the CVAT test and 6 % for the GPT test . The idea was to provide an upper limit for premiums that a policyowner could pay into a life insurance policy and still qualify for the tax benefits of life insurance . The challenge recently has been that bond rates have fallen to historical lows , straining a key element in insurers ’ investment portfolios . Indeed , some bond rates are below the fixed rate assumptions used in the 7702 testing . This has led insurance company reluctance to issue some cash value products , particularly whole life policies .
The amendments in the new law address this issue by allowing rolling interest rate assumptions and permitting maximum policy premiums to change as often as once a year . The immediate benefit of these changes is that under most circumstances policyowners of whole life policies will be able to pay more premiums into their policies . This helps the insurer be more comfortable with offering the product in the first place , while it potentially provides longer term product viability for the buyer . The broader impact — offering products that are attractive for funding situations where cash accumulation is a key motivator for the policy purchase .
Changing landscape
Now the hard work begins for insurance companies . While they have the added flexibility available through improvements to 7702 , they also must grapple with a changed mortality landscape , new approaches to underwriting , and the continued strain of low interest rates . The pandemic has drastically altered the environment insurance companies are working in . COVID-19 suddenly distorted life expectancies , a key component of life insurance pricing , as well sidelined many of its sales agents . And even though the amendments to the law allow the consumer to pay more into a life insurance contract , this doesn ’ t mean that insurers will see a rise in returns on their bond portfolios . More viable ; more flexible ; and definitely more attractive to buyers who want to max fund their policies . But not less expensive .
In the coming weeks and months , life insurance companies will be scrambling to reprice , illustrate and file their new permanent life portfolios — in part based on the changes allowed by the amendments to Code Section 7702 . It will be interesting to see where these changes take life insurance sales . Insurers will have added flexibility , but how will consumers respond when the changes potentially mean a higher cash outlay ?