Last week, we received an announcement that with effect from 1st July 2021, the policy illustrated investment rate (PIRR) will be lowered from 4.75% to 4.25% and 3.25% to 3.00% respectively.
What is Your Policy’s Illustrated Investment Rate (PIRR)?
Some of your insurance policies accumulate cash values. You contribute additional capital, on top of insurance charges to it.
The insurance companies will take your capital and invest in a participating fund. You can see this partipating fund as a pool of stocks, bonds, cash, property investments managed by a group of managers, much like your unit trust, hedge fund with a certain mandate.
The performance of this participating fund’s return determines how much cash value is accumulated.
Typically, endowment plans, limited whole life plans are the kind of policies whose cash value is tied to the performance of the participating fund.
Term plans do not accumulate values so they are not impacted by this illustrated investment rate in any way. Investment-linked policies (ILP) performance is tied to the underlying unitt trust chosen and therefore are not affected by this. Universal life policy returns are typically determined by crediting rate or a hybrid benchmark for those indexed link, so they are less affected by this as well.
The following extracts are taken from a policy’s benefits illustration:
You can see that there are two investment rate of return provided to illustrate to you how much value your policy will accuulate in due time.
One is a optimistic rate (4.75% a year) the other is conservative (3.25% a year)
This is for illustrative purpose. It does not mean that the eventual investment return will fall between 3.25% and 4.75%.
Here are the actual historical investment return of different insurance companies:
You will notice that year to year, the investment return varies.
It is important for you to note: You do not get this return. There are insurance and investment cost that have to be deducted.
The benefits illustration tells you IF the long term returns is 3.25% or 4.75%, that is the cash value accumulate. Not that you will earn all the 3.25% or 4.75%.
In the past, I have crowd-sourced the actual cash value policy returns of matured policy.
When these readers, family members were recommended these policies, the illustrated investment returns were higher. Some may be 7% and 6%. Some were 5.25% and 3.75%.
The eventual returns were in this range.
What are the Illustrated Changes?
Basically when these policies are recommended to you, the illustrated investment rates will be lowered:
- Optimistic rate down from 4.75% to 4.25%
- Conservative rate down from 3.25% to 3.00%
Here is the official word:
This is part of the industry’s annual review of the caps of the illustrated rate of return to ensure ongoing relevance and appropriateness.
The change is made after careful consideration of historical, recent and potential future global economic market outlook, in particular market interest rates, which has decreased significantly over the last few years.
The last revision of PIIRR was made in 2013.
The PIRR is for illustrative purposes, and do not represent the upper and lower limits of the investment performance of an insurer’s participating fund.
The rates used in the PI are not a reflection of the actual returns of both existing and future PAR policies. The actual returns received from a PAR policy will depend on the actual experience, including investment performance, of the PAR Fund that will develop over the lifetime of the PAR policy.
Actual investment returns in the future will depend on the future economic conditions, actual asset class returns and asset allocation of the PAR Fund. Eventual actual returns received by policyholders may be higher or lower than those reflected within the PI.
Here are the illustrated rates used, from what I can remember:
|1994 to 1997
|1997 to 2002
|2002 to 2013
|2013 to 2021
|2021 July onwards
What is the Likely Impact?
I think in terms of actual impact this is low.
These are after all illustrations. Not the actual returns.
However, reducing the illustrated rate does make it more challenging to sell to sell to prospects.
If you review the illustrations, the project cash value of the conservative rates look quite “pathetic” in the eyes of prospects.
The IRR or long term “interest rate” is around 2% a year now. Now, they have to adjust it lower to less than 2%!
It is no wonder that sales people will shift the attention towards the optimistic rate of 4.75%.
The falling illustration rate is a function of our low growth environment. The primary driver is future bond returns.
Participating funds have severe limitation to what they can invest in. Typically they are 60-65% bonds, 35%-40% equity.
Future bond returns are strongly correlated to current yield, and current yield is much lower than in the past.
And if the participating funds has majority of the allocation in bonds, future returns will be low.
Equities are at high long term valuations, and in the long run, your returns are very much tied to long term valuations. The likely returns, estimated on a conservative basis will be lower.
Your future returns are likely to be lower.
Insurance companies have contractual obligations to you the policy holder. So they have to very careful in their estimation and what they can invest in.
To take on more risks in the participating fund, the insurance company may need to set aside more reserves. Setting aside more is an overhead for the insurance companies.
All in all, this points to a challenging environment.
I am starting to hear some of the higher ups say the business of participating funds is not good in the future.
I do expect the marketing to change and influence prospects to shift to investment-linked policies. These policies are less constrained and the prospect has a higher probability to have higher accumulated cash value.
Its just taking on more risks.
However, most of the investment-linked policies are active unit trusts, and these policies have a complex cost structure.
The active unit trusts operate in a similar low return, high valuation economic regime as the participating fund as well.
Let me hear your thoughts.
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