How The Stock Market Affects Your Life Insurance Policy
Written By Cameron McDowell
Sep 15, 2021
11 mins read
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How The Stock Market Affects Your Life Insurance Policy: Why Your Insurance Coverage Is Still Safe
One of the industries that tends to be greatly impacted by stock market fluctuations is life insurance. Because these changes affect the life insurance industry at large, how does the stock market affect your life insurance policy as a consumer?
In this guide, we’ll explain how the stock market affects your life insurance policy. We’ll talk about how market fluctuations influence various types of life insurance, whether investing with your insurance is a good idea, as well as tips on how to protect your insurance from the stock market’s uncertainties.
Why Life Insurance Companies Are Affected By The Stock Market
To receive protection from life insurance, you’re required to pay a cost called a premium. The premiums insurance companies gather will be used to pay out death benefits every time a policyholder’s family makes a claim.
However, premiums aren’t the primary source of profit for insurers. Life insurance companies receive very little profit from premiums because most of the money they receive goes into paying claims and administrative costs. Therefore, the life insurance sector cannot subsist on premium payments alone.
To make money, life insurance companies invest part of the premiums they collect in stocks and bonds. The returns they get from these investments make up the bulk of their profits.
To ensure that they can still pay death benefits, the government requires them to keep a surplus to ensure that claims can always be paid. Insurance companies are also limited to investing in blue-chip stocks that are guaranteed to perform well regardless of market conditions.
Fluctuations in stock market prices would mean that their investments may perform poorly. Because poor investment performance leads to loss of profits, they may decide to increase their insurance rates.
Another factor that may influence an insurance company’s performance during an economic downturn is the increase in claims and insurance fraud. If insurers do not have enough surplus funds to handle all these claims, they may also need to raise premiums to make up for the loss.
How The Stock Market Affects Different Life Insurance Policies
In addition to affecting insurers at large, the stock market may also influence various types of insurance policies to varying degrees.
Whole Life Insurance
Whole life insurance policies usually feature a cash value that grows as you make premium payments. During your lifetime, you can borrow against this cash value or use it to pay your insurance premiums.
In addition to lifelong life insurance coverage, a whole life policy offers the most stable cash value compared to other types of cash value policies. This stability comes from their fixed interest rates. These rates are usually determined by your insurer when you apply for the whole life policy and remain the same for your entire coverage period.
Because whole life policies feature fixed cash value growth based on what the insurer can afford, the market won’t have a noticeable influence on this type of policy.
Universal Life Insurance
Different from whole life insurance, universal policies feature the cash value as an investment component. Returns are based on market indexes from certain categories like the S&P 500.
To prevent cash value loss, universal policies usually come with a return floor that stops your cash value from reducing – even if the index does poorly. However, while the cash value you already have won’t depreciate, the amount of returns that build up your cash value may fluctuate.
Another thing to keep in mind is that universal life policies also implement a return cap. This means that even if your investments perform exceptionally well, you won’t be able to reap the maximum amount of profit compared to investing in the indexes yourself.
Variable Life Insurance
In a variable life insurance policy, your cash value returns are dependent on the underlying investments. These investments could be stocks, mutual funds, bonds, or other investment options.
However, the key difference of a variable policy is that your cash value is completely reliant on your investment’s performance. This makes variable life insurance very sensitive to the fluctuations of the current market. Due to this, variable life insurance is seen as being riskier compared to universal policies.
If your investments perform poorly, you may need to either lower your death benefit or increase your premium payments to avoid losing your cash value. In cases where your investments perform especially poorly, you may also be at risk of losing your policy.
Term Life Insurance
Unlike the three types of permanent life insurance covered above, term life insurance is much less sensitive to the changes in the market, especially because it doesn’t have a cash value. Term policies are usually more resistant to short-term changes, so you don’t have to worry about its premiums fluctuating due to the current market floundering.
However, this doesn’t mean that term life insurance is immune to market conditions. If the economy shifts constantly, then term insurance rates may follow suit. Regardless, recent shifts in the market will likely not influence term insurance rates as they are now.
Will Stock Market Changes Influence My Insurance Coverage?
Because most insurance companies make the bulk of their profits in the stock market, any changes will directly impact their bottom line. However, life insurance policyholders won’t experience the same amount of impact as insurers.
To ensure insurers are liquid enough to pay insurance claims, the federal government issues guidelines about how much money life insurers should have in reserve. Insurers are also given guidelines on ownership of enough stocks with a fixed interest rate and are offered reinsurance if the company is unable to fulfill their policyholders’ claims. These guidelines minimize the impact of an economic downturn on the life insurance industry and insurance owners.
In addition to the federal guidelines, policyholders’ rights are also protected by regulations put forth by state legislations and the National Association of Insurance Commissioners (NAIC). These regulations are meant to protect policyholders from unfair pricing and ensure that their funds are safeguarded.
If you have a policy provided by a top life insurance company, you shouldn’t worry about your coverage being influenced by stock market fluctuations. However, if you want to be sure of your insurer’s ability to pay claims, you can check your insurer’s financial strength by consulting insurance credit rating agencies like A.M. Best, Moody’s, and Standard & Poor’s. If your insurer is rated highly by them, then they’re likely to be capable of paying your death benefit claims on time.
Reasons To Invest Using Life Insurance
The market always fluctuates! However, with each downturn and uptick, you can expect it to eventually correct itself. Therefore, you can still benefit from making an investment using life products. In this section, we’ll cover three reasons why investing with life insurance could be right for you.
Offset Your Estate Tax
When you die, your family may need to pay an estate tax charged on your assets. In order to offset this, you can invest in a life insurance policy with a death benefit amount that equals your projected estate tax.
For instance, if you have $13 million in assets and you expect to be charged an estate tax of $1.4 million, you can apply for a permanent life insurance policy worth that amount. Because your insurance death benefit is tax-free, your beneficiaries can use it directly to pay for estate taxes.
Your permanent life insurance payout can also help if most of your assets are real estate. Because estate taxes need to be paid within nine months of your death, having money to pay these taxes immediately will lift a huge financial burden from your loved ones.
Supplement Your Retirement Income
Retirement funds like 401k and IRA have contribution limits. If you’re a high-earner and you need to supplement your retirement funds, you can invest in a cash value permanent life insurance policy. Any type of permanent life insurance policy that features cash values can be a good tax-free choice for an additional savings vehicle.
Provide Lifelong Insurance Protection
Most life insurance options with investment components are permanent life insurance policies. This means that you can benefit from its investment returns your whole life, and your family can benefit from your insurance payout when you pass away – no matter when that is. In addition to that, you can also purchase riders to add long-term care coverage so you’ll be able to pay for end-of-life costs.
Caveats Of Investing With Life Insurance
While investing with your life insurance can be right for you, there are some things that you need to keep in mind.
High Administrative Costs
All cash value insurance policies charge fees, but life insurance contracts with investment components generally feature more of them. These additional fees are used to pay for the management of your investment funds. Withdrawing or borrowing against your cash value may also saddle you with extra administrative costs.
These extra costs also mean that not all of your premiums go toward the cash value. Say that you pay $50 in premiums monthly. If $10 goes to the death benefit, then the remaining $40 won’t all go to your cash value. Some of it will be used to pay your management fees and other insurance costs. After those costs are paid, then what remains will go into your cash value.
Investment Return Limits
If you’re investing in a universal life policy, the insurer will limit your losses and gains using return floors and caps. Floors ensure that even if your investment performs poorly, your cash value won’t depreciate.
However, you’re also limited by the return cap. Even if your investment performs well, your gains will still be limited. For instance, if your investment earns 10% but your universal life insurance has an 8% cap, you’ll only earn as much as the cap allows.
In addition to return caps, universal life insurance doesn't take dividend yields into account. Because you didn’t invest in the index directly, you won’t receive any dividend payments like other shareholders.
Variable and universal life insurance policies are highly dependent on how well your investments do in the market. If your investment assets perform better than expected, you can enjoy lower premium payments and better cash value buildup.
However, your policy’s value may suffer if your investment performs poorly. While a universal life policy has a floor that prevents your losses from devaluing your cash value, variable life insurance doesn’t feature any safety nets.
In a variable policy, you may have to pay more premiums if your investment underperforms. If they perform especially poorly, you may be forced to accept a lower death benefit or lose your policy entirely.
Protecting Your Insurance Policy From Stock Market Fluctuations
In these uncertain times, you may be worried that the stock market will influence your insurance premiums or investments. To help alleviate those worries, you can follow some of the tips provided in this section.
Opt For Non-Investment Life Insurance
Cash-value life insurance, especially those with an investment component, are especially susceptible to changes in the market. However, term life insurance typically doesn’t feature an investment component and is less prone to changes in the short-term.
If you’re just looking for a death benefit to protect you and your beneficiaries, we recommend that you opt for term life insurance. Its stability means that you’re unlikely to see any rise in premiums in the near future, even if the market keeps shifting.
If you still need a cash value on your policy, you can choose whole life insurance. Because whole life insurance provides cash values at predetermined interest rates, they’re less susceptible to changes in the market.
Choose Other Investment Methods
While the market will eventually correct itself, investing in it may still be a risky proposition for you. This also applies to all insurance policies that feature a stock investment component.
If you still need to invest, you can opt for non-stock market investment alternatives. You can choose precious metals, treasury securities, real estate, among other options. However, you should always do proper research and ask for information from financial professionals before committing to these investments.
Check Your Insurance Company’s Rating
Life insurance companies are closely regulated by the federal government. These regulations ensure that they’re able to pay their policyholders’ claims even in an economic downturn.
If you’re insured by a major insurance company, they should also have safety measures and cash in reserve to pay your claims regardless of how their investments perform. However, if you’re protected by a smaller insurer, you may have reason to worry because their cash reserve will be smaller.
Whether you’re insured by a large or small insurance company, it’s a wise idea to look up their ratings on an insurance rating site. Sites like A.M. Best and Standard & Poor’s rate insurers by their ability to pay out claims as well as their company performance. To ensure that your insurance company can reliably pay out your claim whenever it’s made, you should look for life insurers that are rated Excellent or higher.
Consult An Independent Insurance Agent
Finding the right life insurance protection can be a confusing affair. Combine that with all the life insurance investment options available, it could easily be overwhelming for you. To help you choose between all the available options, you can enlist the help of an independent insurance agent.
Good life insurance agents can take into account both your insurance and investment needs to find a policy that fits your circumstances and risk tolerance. In addition to that, they can also help you save money by finding policy discounts that you may not have otherwise known about.
The stock market is in a state of near-constant change. However, due to federal regulations, there shouldn’t be any major effects on your life insurance death benefit and insurance companies should still be able to pay your claims when needed.
If you’re looking to invest using your life insurance, Wesley LLC is here to help! Our team of financial experts will advise you on how to navigate the market and make the most returns out of your life insurance policy investments. Contact us today for more information!