[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 since last month, the timing of a rate cut has been delayed, and market interest rates have been rising day after day.

The reason for the discrepancy between policy loan rates and market rates is that, unlike banks, insurance companies cannot quickly respond to changes in the benchmark rate. Policy loans use the reserve interest rate (the interest rate applied to insurance reserves) as the benchmark. For loans, fixed-rate products are based on the projected rate, while floating-rate products are calculated by adding a spread to the declared rate. For policies signed when interest rates were low, policy loans 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%, while Kyobo Lifeplanet Life (3.84%), NH Nonghyup Life (3.88%), AIA Life (3.9%), KB Life (3.96%), and KDB Life (3.97%) also maintained 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 simply means there are many savings insurance products sold during past high-interest periods, which is not necessarily a good thing. Since the declared rate does not change frequently, the sensitivity to interest rate changes is inevitably low."

The problem is that when market interest rates rise, insurers' funding costs also increase, so if the decline in loan interest rates is prolonged, insurers' investment returns are expected to decrease accordingly. As of the third quarter of this year, the balance of policy loans at insurance companies 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 allowed to apply preferential rates to policy loans starting this month, leading to a competitive atmosphere for rate cuts. Recently, most insurers have introduced new requirements for preferential rates, ranging from 0.1% to as much as 5%, as part of their marketing strategies. NH Nonghyup Life has decided to offer preferential rates of 0.1% to 5% to policyholders with contracts exceeding a projected rate of 5%. Fubon Hyundai Life applies a preferential rate of 0.4% to new customers using non-face-to-face online channels. Lina Life offers a preferential rate of 0.35% to customers aged 65 and older.