Should Variable Policy Loan Interest Rates Be Adopted?

Abstract

The final report of the Presidents' Committee on Financial Structure and Regulation has recommended that serious consideration be given by the life insurance industry to changing a long standing practice of making loans available to policyholders at fixed interest rates, usually 5 or 6 percent. The proposal is to switch to a variable interest rate system under which borrowing rates in life insurance would change with market interest rates. This system has been widely adopted abroad. A major advantage claimed for the proposed system would be to slow down the disintermediation process which has caused some life insurers to lose substantial amounts of investible funds when market rates of interest exceed the fixed rates. It is argued in this paper that the variable interest system might have more disadvantages than advantages for the life insurance industry and for policyowners; it would be no panacea for many of the ills about which certain members of the industry are complaining. For a variety of reasons, discussed below, life insurance companies in the United States have been concerned with the problems caused by the fact that most life insurance policies now specify fixed rates of interest applicable to policy owners who borrow on policies with cash values. In periods of tight money and high open market interest rates, this has produced substantial increases in policy loans and has tended to disrupt the direction of the normal flows of capital through life insurance companies. In the recent report of the Hunt Commission,'' developed after two years of Mark R. Greene, Ph.D., is Distinguished Professor of Insurance in the University of Georgia. Dr. Greene is a Past President of A.R.I.A. This paper was submitted in October, 1972. The author acknowledges with appreciation the helpful comments and criticisms of an earlier draft of this paper by Mr. Abram T. Collier and E. N. Wadsworth of New Enaland Life Insurance Co., and to Dr. John W. Eilert of the professional staff of the Life Insurance Association of America. 1 The report of the President's Commission on study and investigation, specific recommendations on life insurance structures were made, which included one to amend state laws to allow life insurers to issue policies containing flexible policy loan interest rates, subject to appropriate usury laws establishing interest rate maximums. In justifying this recommendation, the