Life Insurance: Why Tying Policies to Market Interest Rates is Insufficient(AI Translation)

【周刊提前读】人身险重回2.5% 为何挂钩市场利率不足以消除利差损？

Following the recent decline in bank deposit interest rates, a corresponding cut in the insurance industry has also come into effect. On August 2, 2024, the National Financial Regulatory Administration (NFRA) issued a notice titled "Notification on Improving the Pricing Mechanism for Life Insurance Products" which announced that starting September 1, 2024, the maximum assumed interest rate for newly registered standard insurance products will be lowered from 3.0% to 2.5% [para. 1][para. 2].

This reduction reflects ongoing market trends of lowering interest rates and aims to reduce liability costs in the life insurance industry while preventing interest rate spread losses [para. 2]. The last major adjustment in the insurance industry occurred between 1996 and 1999, which saw a dramatic drop from 10% to 2.5% due to consecutive rate cuts, causing significant risk of interest rate differentials for life insurance companies during that period [para. 3][para. 4].

From 1999 onwards, a fixed 2.5% interest rate was maintained for 14 years until market-oriented reforms were introduced in 2013 [para. 5]. The current return to a 2.5% era marks another pivotal moment in the industry [para. 5].

The new notice introduces a dynamic mechanism for linking pre-determined interest rates with market rates, thereby enabling more flexibility in insurance product pricing [para. 7]. Although specific details regarding this linkage mechanism have not been provided, the system is intended to adjust dynamically according to changes in long-term market rates like the Loan Prime Rate (LPR) and ten-year government bond yields [para. 8][para. 9]. Regulatory officials highlight that the newly proposed mechanism could guide insurance companies away from simply pushing interest rates to their regulatory limits and allow them to better manage liabilities and assets [para. 9][para. 10].

Effective September 1, 2024, the maximum presumed interest rate for new general insurance products will be 2.5%, and the rate for participating insurance products will be capped at 2.0% starting October 1, 2024 [para. 16]. Similarly, the ceiling for newly filed universal insurance products will be set at 1.5%, coming into effect from October 1, 2024 [para. 16]. This urgency stems from declining market interest rates, exemplified by the yield on a 10-year government bond dropping to 2.16% as of August 8, 2024 [para. 16][para. 17].

Another significant change is the stringent timeline for these adjustments, which allows just over a month for implementation, limiting the market's opportunity to delay sales for higher presumed interest rates [para. 18].

Despite these developments, the current product structure poses challenges. Long-term savings-type insurance products are particularly vulnerable to interest rate fluctuations [para. 20][para. 21]. Hence, the notice underscores the value of dividend insurance products, which offer a "guaranteed minimum + floating" returns model, better aligning with interest rate changes and mitigating interest spread risks [para. 21].

Additionally, the notice mandates that insurance companies clearly distinguish sales channels and expense structures in their product documentation [para. 23]. This aligns with previous regulatory suggestions from officials and emphasizes the need for further detailed operational controls and strategic adjustments in the insurance sector [para. 25][para. 26][para. 27][para. 28][para. 29].

Regarding the linkage mechanism, the experience with market-based adjustments in bank deposit rates offers a relevant parallel but indicates the need for a comprehensive framework suited for the long-term nature of insurance products [para. 34][para. 35]. Experts suggest life insurance products' pre-determined interest rates should closely mimic the 10-year government bond yield but emphasize that predicting future interest rates remains highly complex [para. 36][para. 38][para. 39][para. 40].

The introduction of this dynamic pricing mechanism represents a progressive step from previous reforms that aimed to liberalize life insurance premium rates starting in 2013. However, the challenges of maintaining true market-oriented principles within a regulated environment persist [para. 41][para. 42][para. 43]. The new measures introduced by the NFRA and the continued focus on enhancing asset management rules further highlight the sector's efforts to adapt to changing market conditions and regulatory expectations [para. 46][para. 47].