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Gabriel Lalonde
July 13th, 2022

Impact of Rising Interest Rates on Participating Life Insurance Policies

There are many indications that interest rates could rise a number of times over the course of 2022. Last week we saw the first increase in benchmark interest rates since 2018. How will that impact your life insurance policy and the structure put in place as part of your estate and business succession plan?

Business owners and entrepreneurs who own participating life insurance policies will recognize that life insurance companies use long term assumptions for rates of return on assets invested in the participating account, insurance claims, expenses and policy terminations when pricing participating life insurance products. These pricing assumptions are used to determine the guaranteed basic premium, guaranteed basic coverage, and guaranteed cash value. When actual results for any of these factors in combination are better than what was assumed in pricing the products, a policyowner dividend may be distributed. So how can rising interest rates impact the actual results for rates of return?

Premiums from all participating life insurance policyowners go into the participating account, which is invested in a mix of fixed income (such as public bonds, private placements or commercial mortgages) and non-fixed income investments (such as public equity, real estate or private equity). The overall exposure to fixed income vs. non-fixed income matters – a higher mix of fixed income assets may mean a greater impact from rising interest rates.

In a rising interest rate environment, we would generally expect to see pressure on the market value of fixed income investments, such as bonds. However, when calculating the participating account’s investment return and dividend scale interest rate (DSIR), many companies do not include unrealized losses or gains for fixed income assets (which are not divested during the year). What this means is that lower bond prices (from higher interest rates) won’t be captured in the DSIR – unless that asset is sold during the year. Uniquely, the income or coupon component is the key driver for fixed income asset returns.

The length of the fixed income portfolio is also a key consideration – shorter duration fixed income portfolios mean faster reinvestment of existing assets into new money rates available in the market. Therefore, the level of current market interest rates is important as those assets are reinvested – if current new money interest rates are lower than those of existing portfolio fixed income assets, that will result in further downward pressure on the DSIR. Rising interest rates will help to alleviate that pressure and may ultimately have a positive impact on the DSIR if market interest rates are above maturing asset yields.

The impact of rising interest rates on non-fixed income investments is more uncertain. If interest rates are rising due to a strong economy, then asset classes like public equity can perform well. However, as interest rates increase, especially real interest rates, there is the potential for pressure on the returns for some of those non-fixed income asset classes.

Ultimately, rising interest rates may impact the underlying asset classes in varying ways. However, given that many participating accounts continue to hold the majority of their assets in fixed income investments, all else equal – higher interest rates could potentially lead to an improved outlook.

Many high-net-worth clients use a strategy which assigns their participating life insurance policy to a bank or other lending institution as collateral for a loan. Depending on the variation of the strategy used, the loan generally replaces all or a significant portion of the funds used to pay insurance premiums, thereby preserving cash flow needed to continue growing your business or investment portfolio. Interest rates on these loans are typically floating rates of Prime + a spread. As interest rates rise, the interest rate charged on these loans will also rise, increasing the cost of the loan each year. Although rising interest rates will increase the annual cost of the program, it can still be a cost-effective way to obtain the life insurance coverage needed as part of your business and estate plans.

With any strategy, it is important to test under different assumptions. The life insurance illustrations created use different assumptions for policyholder dividends that may be credited. This is done to demonstrate the impact over time on policy cash values and death benefit of differing DSIRs. It’s important to note that dividends are not guaranteed nor are the life insurance illustrations.

The same type of sensitivity analysis should be done on the loan interest rate, demonstrating a combination of rising and falling interest rates in combination with increases and decreases in the company’s DSIR. This will demonstrate the impact on the net cost of the strategy under varying scenarios.

If you are concerned about rising interest rates, reach out to your insurance expert and request they run inforce illustrations for the life insurance policy and sensitivity test those illustrations under increasing interest rate scenarios.

The information provided is accurate to the best of our knowledge as of the date of publication, but rules and interpretations may change.

This article has been written and provided by The Canada Life Assurance Company.

Most business owners are big on cutting costs to save money. However, only a few know how to maximize their corporations to enjoy great investment and tax-saving opportunities. Does this describe you? You are at the right place. Read on to learn five corporation-based strategies that maximize investment gains and minimize taxes.

5 Tax-Saving Corporate Investing Strategies

  1. Earn dividends instead of salaries.

Contrary to popular belief, paying yourself a dividend is more beneficial than earning salaries. For instance, you do not have to pay into your Canada Pension Plan if you earn a dividend. This way, you can keep up to $6,000 in your corporation to invest as you wish. At that rate, you can expect about $240,000 in 40 years and better control over your savings.

  1. Avoid pulling money out of your corporation.

The second strategy is to ensure you keep as much money as possible in your corporation. Business owners often move their corporation’s money into a Retirement Savings Plan (RSPs). Unfortunately, this is a wrong move, and here is why: while withdrawals from your corporation account are tax-free, every withdrawal from your RSP attracts a 50% tax rate. This means you remit 50% of the money back to the CRA. Conversely, taking money out of your corporation as dividends attracts less income tax.

  1. Invest in investments offering capital gains.

Investments like stocks, corporate class mutual funds and real estate are great examples of capital gains-producing investments. Ottawa CFPs often recommend these capital gains because their tax rates are more favorable than interest or dividend income.

In addition to lowering your payable tax, capital gains also allow you to create Capital Dividend Account (CDA) credits, through which you can withdraw money from your corporation without tax.

  1. Use corporate dollars for your life insurance premium.

Your corporation should be the owner and payer of your life insurance premiums. With this arrangement, you can easily pay your premiums with corporate dollars and enjoy the lower tax rates (11% in BC). If you pay with your personal money, the tax rate could be as high as 50%. Therefore, if done correctly, you can save considerable money on taxes.

  1. Invest in corporately-owned whole life insurance.

Here is another way to save taxes – adopt corporately-owned whole life insurance. This strategy eases tax burdens on you and your family on demise. How? When a business owner dies, the remaining cash in the corporation account is expected to go into the CRA. However, if such a business owner invested in corporately owned whole life insurance, the money will go to their family or their preferred charity upon death. Corporately-owned life insurance is also one of the tools to create a tax-efficient retirement.

Final Thoughts: Corporate Investing Strategies Takes You Closer to your Financial Goals

All five strategies mentioned above will help you a lot in your quest to achieve your financial goals. Implement them with the help of your Ottawa-certified financial planner and watch your tax reduce and your savings grow today, tomorrow, and even when you are no more. This move will also transform your quality of life and ensure steady growth.

Are you interested in learning more about our financial planning process? Call us today to schedule an appointment.

Gab

About Gabriel Lalonde, CFP, CFEI, B.A.

When Gabriel is not crunching numbers, you can find him accompanied by his beautiful wife Ana and son Théo, either on the golf course in the summer or the ski slopes in the winter. His dream has always been to take over the family business as he saw first hand how much impact his father had on shaping peoples lives and creating long lasting legacies. Gabriel has a true passion for financial literacy and he believes everyone should have access to solid financial education.

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