[1mm Finance Talk] Why Are Insurance Policy Loan Rates Falling While Market Rates Rise?

Policy Loan Rates Fall to 4.21% at End of October, Down from First Half of Year
Three-Year Treasury Bond Yields Hit Yearly High
Insurance Companies Face Shrinking Margins as Preferential Rate Competition Intensifies

Although the timing of a benchmark interest rate cut has been delayed and market interest rates are rising, the interest rates on insurance policy loans offered by insurers are actually showing a downward trend. As financial authorities have recently eased regulations, insurance companies are increasingly competing to offer preferential rates, raising concerns that they could fall into the trap of negative funding margins.

According to statistics from the Korea Life Insurance Association as of the end of October, the average interest rate for floating-rate policy loans at 22 domestic insurance companies was 4.21%, down 0.12 percentage points from 4.33% at the end of the first half of this year. A policy loan is a system in which policyholders borrow money using the surrender value of their insurance policy as collateral. Since there is no screening process and it does not affect the borrower's credit score, it is often used by ordinary people as a source of emergency funds.

While policy loan interest rates have been falling, market interest rates have moved in the opposite direction. According to data from the Korea Financial Investment Association, the yield on three-year government bonds soared from 2.452% at the end of the first half of the year to a yearly high of 3.084% as of December 9. As the Bank of Korea has kept the benchmark rate unchanged for four consecutive times, the timing of a rate cut has been pushed back, leading to a steady rise in market rates.

The disconnect between policy loan rates and market rates is because insurers, unlike banks, cannot respond quickly to changes in the benchmark rate. Policy loans are based on the reserve interest rate (the rate applied to insurance reserves) as their benchmark. For loan interest, fixed-rate loans are calculated based on the assumed interest rate, while floating-rate loans are based on the declared interest rate plus a spread. Loans taken out against policies sold in the past, when rates were low, are structured to have lower interest rates.

As of the end of October, floating-rate policy loan interest rates by insurer ranged from the upper 3% to the low 5% range. Hana Life had the lowest rate at 3.75%, followed by Kyobo Lifeplanet Life (3.84%), NH Nonghyup Life (3.88%), AIA Life (3.9%), KB Life (3.96%), and KDB Life (3.97%), all maintaining rates in the 3% range. Samsung Life (4.53%), Heungkuk Life (4.42%), and Kyobo Life (4.41%) were among the insurers with rates in the 4% range. An industry official commented, "Even if policy loan rates are high, it only means that there are that many savings insurance policies sold during high interest rate periods, so it's not necessarily a good thing. Also, since the declared interest rate does not change frequently, the sensitivity to interest rates is inevitably low."

The problem is that as market rates rise, insurers' funding costs also increase, so if the decline in loan rates continues for a prolonged period, insurers' investment returns are expected to decrease accordingly. In the third quarter of this year, the outstanding balance of policy loans at insurers stood at 70 trillion won, surpassing half of the total household loans (133.3 trillion won).

Furthermore, as financial authorities have relaxed regulations, insurers have been able to apply preferential rates to policy loans starting this month, fueling a trend of competition to lower rates. Recently, most insurers have introduced new requirements for preferential rates, ranging from 0.1% to as high as 5%, as part of their marketing strategies. NH Nonghyup Life has decided to offer preferential rates of 0.1% to 5% to customers with insurance contracts bearing an assumed rate of over 5%. Fubon Hyundai Life applies a 0.4% preferential rate to new customers using non-face-to-face online channels. Lina Life offers a 0.35% preferential rate to customers aged 65 and older.