The Impact of Federal Interest rate cut on our lives and its effect on existing life insurance

As Covid-19 continues to affect the world, life as we know it transformed into a new normal. As many areas of the world begin to ease their respective lockdown measures, the easing of lockdown raises concern about adapting to the new normal. This concern extends beyond health worries to include concerns of a financial and economical nature. As with previous crisis the Federal Reserve stepped in to address the effects of Covid-19 on the U.S. economy by reducing the federal fund rate, aka federal interest rate, twice in the month of March. First from 1.75% to 1.25% on March 3 2020, then from 1.25% to 0.25% on March 16, 2020. The Federal Reserve uses the federal interest rate as a way to manage the U.S. economy. In fact, you can see the impact of the federal interest rate, whether directly or indirectly, in many areas of your financial life. Knowing the federal interest rate’s effect on financial products can help you make informed decisions in your financial life.

One of the most noticeable area of this influence is in the financial institution. For example, when the federal interest rate decreases, the prime rate — the interest rate that banks use to lend money to customer with good credit — usually follows suit. As a result, creditworthy customers may be able to borrow from a bank at a lower interest rate. Because the federal interest rate influences the prime rate, the federal interest rate cut also indirectly affects the retail banking industry, which includes products such as credit cards, loans, and savings account. Typically, with a low federal interest rate, customers can see a better interest rate for their credit cards and auto loans. However, due to rapid pace of the federal interest rate cut, credit card interest rate may have increased, instead of a decrease in rates, or the low interest rate may be offered only to select customers. In addition, customers may find their saving account earning less interests in this low federal interest rate environment.

While the relationship between the federal interest rate and retail banking can be easily linked, one unlikely industry affected by the cut is the life insurance industry. In the life insurance industry, policyowners may see an increase in the cost of insurance or even a reduction in cap rate for their cash value account. In fact, policyowners may already be informed of the adjustments by the insurer. For prospective customers, some life insurance company have increased pricing on some products and some insurers have temporarily discontinued certain products till further notice. This is due to life insurers investing mainly in fixed income securities, in order to fulfill their long-term obligation to the insured. With a low federal interest
rate, the life insurer’s profitability shrinks due to “the spread between the investment returns and what they credit as interest on insurance policies and products” determining an insurer’s profitability [1]. Insurers want the federal interest rate to be raised, because an increase in
interest rate means an increase in profitability for life insurers.

Changes in federal interest rate have a big impact on our lives whether we know it or not. Depending on the type of industry, the increase or decrease of the federal interest rate can be beneficial for customers. However, while there is a general trend in how an industry may respond to the changes of the federal interest rate, companies determine their response to crisis based on the current situation, their company profile, and many other factors. If you are concerned about a product you have that could be affected by the federal interest rate cut, you should review your policies and accounts and check with your provider or financial advisor for more information.

Reference:[1] The Sensitivity of Life Insurance firms to Interest Rate Changes. K. Berends, R. McMenamin, T. Plestis, & R. J. Rosen