7702 Will Bring Big Changes to Whole Life & IUL Later in 2021

Updated February 1st, 2021

Long story short is that Congress revised IRC 7702 in December’s spending bill. This part of the code determines how much premium is allowed before a policy is considered a MEC. It also determines how strong Whole Life’s underlying guaranteed growth rate will be. 

Below is a short video, clickable table of contents, and FAQs outlining why insurance companies lobbied for these changes and what it means for consumers and future product offerings below.

The guarantees of future Whole Life policies will be getting significantly watered-down. However, clients can lock in the stronger lifetime guarantees of classic Whole Life for a short time until these newer product offerings are approved by the Department of Insurance. (Watch Hutch’s 2-minute video take below)

You can also click on any of the topics to skip directly to them:  

 

What is this recent change to 7702 by Congress all about?

If nothing else, 2020 will forever be remembered as a year of major change and the “new normal” in regards to health, work, education, socializing, etc.

Not to be outdone, the life insurance industry has followed suit by encouraging politicians to make some major changes to latest spending bill, which passed both houses of Congress in late December with an effective date of Jan 1, 2021.

Buried deep into the 5,593-page bill are some monumental revisions to IRC Section 7702. This section of the code dictates the premium limits for life insurance policies before they would become a MEC (Modified Endowment Contract) and receive less adverse tax treatment by the IRS. This recent revision represents the first major change to life insurance funding parameters since 7702 was originally enacted in the 1980’s.


Why life insurance companies wanted this change to 7702 and what it did for them

Long story short is that life insurance companies pushed for this change so they could continue operating a sustainable business protecting American policyholders.

Needless to say, interest rates, in general, have been steadily declining since the 1980’s (coincidentally when the original parameters of 7702 were set). Life insurance companies were left in a bind when the fed cut rates in 2020 responding to the economic turmoil of COVID-19.

Although yields inside the insurer’s general accounts were declining, the amount of premium they could collect was tied to an older interest rate assumption derived in the much higher rate environment of the 1980’s. Furthermore, the guaranteed rate set promised in Whole Life policies was based on these same outdated parameters.

According to the WSJ, US House staff said the changes to 7702 were necessary “to reflect economic realities” and give consumers “access to financial security via permanent life-insurance policies.”

Many life insurance products would no longer be sustainable given the current economic environment without a major change to the outdated interest rate assumptions insurance companies had been bound to since the 1980’s. This would obviously hurt the solvency and depended-upon financial strength of life insurance.

How the necessary changes to 7702 affects funding parameters for accumulation-based life insurance products

By slashing the 7702 rate and allowing life insurance companies to maintain a sustainable business model and continue to be a bedrock for American families.

Unlike with death benefit-focused insurance products where clients are trying to pay the least amount of premiums possible for the most amount of coverage, accumulation-based products are optimized by paying the most amount of premium for the least amount of death benefit (to lower the underlying costs).

Once these new products are redesigned and approved by the various State Departments of Insurance, clients will be able to put in substantially more premiums for the same amount of death benefit. The exact ratio is still unknown and will obviously vary by age, health, product type, etc.

Remember, 7702 was originally enacted by Congress to keep wealthy clients from avoiding future taxation by requiring a certain ratio of death benefit for any desired premium amount. 

Try my simple analogy on for size to understand what this means.

In 1980’s the original mandate of 7702 essentially required an oversize envelope to accommodate a stack of $100 bills, even though before they would allow a small envelope to house the same stack of cash. Needless to say, bigger envelopes result in higher shipping costs for the same stack of bills.

For this simple analogy:

  • The envelope space required = death benefit required (before & after 7702)
  • Stack of $100 bills = any given amount of desired premium
  • Shipping rate = ongoing cost of insurance charges

This new change to 7702’s interest rate factor will potentially allow you to stuff in 1.5x – 2x the amount of $100 bills into the same oversized envelope or use a much smaller envelope in 2020 for the same size stack of $100 bills. Either of which would obviously lower your relative shipping rate per bill.

Many people that would’ve previously considered themselves too old or unhealthy for accumulation-based life insurance may be pleasantly surprised with the new parameters. This is especially true since these changes will also apply to survivorship or 2nd-To-Die Policies, where the cost savings will be compounded inside these policies need 2 people to die.

How this change to 7702 specifically affects IUL policies (as well as VUL policies)

Probably the biggest concern that clients have over IUL, VUL, or any non-guaranteed product on a Universal Life chassis (UL), is the potential for increasing fees. Although many pundits overplay this risk like it’s a big scary monster under the bed, well-informed clients have learned that this risk can be substantially mitigated by paying the maximum allowable premiums for the first 4-7 years. Guess what, the new 7702 rates further reduce this risk by allowing you to either:
  1. Pay approximately 1.5x – 2x more premiums into the same amount of death benefit (which the fees are largely based on)
  2. Or, wrap significantly less death benefit around the same premiums
There were some that have speculated that further declines of interest rates may do away with using permanent life insurance as an accumulation/retirement vehicle because it would be so difficult to generate a decent return over and above the internal charges. Heck some wondered if insurance companies selling any kind of non-guaranteed insurance product would have to raise insurance costs on all consumers to make up for the interest rate shortfall. But alas, “New-7702” to the rescue! Now with a leaner more efficient life insurance wrapper, carriers can keep their promises and clients should be able to earn a competitive growth rate relative to alternatives of a similar risk profile in any interest rate environment. For IUL specifically, lower caps and participation rates can be paired with lower fees and lower loan rates (assuming your particular product & company is chosen and designed properly).

(Note: whereas the change in the 7702 rate has no adverse effects on future IUL products, there is one major aspect of it that will negatively impact future Whole Life products, and render today’s Whole Life policies as a classic vintage offering. Read below for more). 

How this change to 7702 will specifically affect future Whole Life policies

Here’s the good news or the bad news for future Whole Life insurance policies with the new 7702 revisions:

  • Good: the new lower 7702 rate will allow bigger front-loaded premiums into the same amount of whole life death benefit, or less death benefit will be needed to wrap around the same premiums required to carry current whole life policies.
  • Bad: the new lower 7702 rates dictate a lower guaranteed cash value growth rate inside future Whole Life policies. (Remember that any PUA payments as well as dividends purchasing PUAs are added directly to the guaranteed cash value balance and ride on a growth trajectory dictated by the 7702 rate when your whole life policy was originally purchased).

What does this mean?

It means that even though the newer Whole Life policies will accommodate more premiums, the lifetime guaranteed growth of these new policies will compressed. So, much more of the cash value growth will be tied to the company’s fluctuating dividend scale (which is non-guaranteed), and less will be derived from the company’s guaranteed cash value trajectory.

So unlike with IUL, where you may want to wait for the new and improved version, with Whole Life you will most likely want to lock in the current classic version without the compressed guarantees.

Don’t get me wrong, whole life companies will undoubtedly create future products that are competitive, but the total return will be tied to non-guaranteed factors, which they can toggle unlike the guaranteed cash value component.  Often the most attractive feature of Whole Life is the guaranteed growth that clients can stack in their favor by adding term riders and paying disproportionate PUA payments). This guaranteed feature will be watered-down in future versions of the product due to the recent changes to the 7702 rate.

Also, it appears that the Reduced Paid-Up Nonforfeiture option (RPU) will also be significantly compromised with the new product. This feature allows clients to stop paying premiums and accept a reduced (but contractually guaranteed) amount of insurance at any time during the life of the policy. Clients will use this either as an escape hatch to stop paying premiums when their financial circumstances change or as a way to optimize cash value growth once they are finished funding their policy.

Once the RPU option is elected, a whole policy is shed of mortality charges and both the cash value plus the death benefit are guaranteed to grow from there. The new lower 7702 rate will make the RPU assumptions much less favorable than what exists with today’s whole life policies.

Obviously, the new changes will help whole life companies run a sustainable business and keep these promises to existing policyholders, so those who acquired these older products can enjoy the soon-to-be EXCTINCT guaranteed parameters.

The last time the top-performing Whole Life company shelved a mispriced product, they gave agents just over a week’s notice to sell the old product before it went away for good because they didn’t want a fire sale on a product that way no longer a sustainable offering for them on a mass scale.

The guarantees of future Whole Life policies will be getting significantly watered-down. However, clients can lock in the stronger lifetime guarantees of classic Whole Life for a short time until these newer product offerings are approved by the Department of Insurance. (Watch Hutch’s 2-minute video take below)

FAQs about the change to 7702

No it does not. Your policy would use the 7702 parameters in place at the time of issue.

It depends. Every carrier will be different. They must have their actuaries design the products, get departments of insurance to approve the product, and adjust illustration software to accommodate the launch. We’re just hearing murmurs at this point, but some companies have said sometime in February, others by March, and others by Summer. We shall see.

Most likely no, but this is case dependent. Whenever you roll existing cash value into a new policy via 1035 exchange, the “rollover amount” is considered a premium and will be subjected to any premium load charged by the new policy. Even if the new contract is substantially more efficient, your cash value will have to take a step back to take strides forward. This is something we often to model for new incoming clients with older policies. We often find they are more comfortable retaining older policies if they are decent, although in the worst cases it may make sense to switch. Most often though we can help them optimize the existing policy so that it no longer requires future premiums so they can keep it while diverting new money premiums into a more efficient offering. Schedule a custom call to discuss your rollover options and best course of action for your situation going forward.
Well that all depends, and we must disclose that you always run the risk of becoming less healthy or dying while you wait. However, assuming you stay healthy, the new IUL seems like it will be worth waiting for, while the old Whole Life has some clear advantages that will soon be obsolete (namely the stronger guaranteed growth rate and RPU parameters). Feel free to schedule a quick call to discuss your optimal options.

Most likely yes, since the industry lobbied hard for this change throughout 2020. Let’s face it, the old parameters were antiquated and costing them money. For that reason, we expect to see all life insurance companies create new products adopting these new parameters thereby making their business more sustainable.

Final Thoughts on the Recent Changes to 7702

The recent changes to 7702 brought about by the Consolidated Appropriations Act of 2021, were necessary for the sustainability of the entire life insurance industry as we know it. By updating the antiquated interest rate assumptions originally set forth in the 1980’s, insurance companies can continue offering competitive accumulation products while maintaining promises to prior policyholders.

Clients who cherish the iron-clad guarantees of Whole Life insurance may want to lock them in with the current product offerings that will soon be extinct.

For those looking to maximize their upside potential with IUL/VUL and aren’t as concerned with the fluctuating fees at the core of these products, the upcoming changes will minimize this risk even further by allowing them the opportunity for growth on larger premiums outrun compressed charges.

Although these major changes will undoubtedly reshape the industry as we know it, it ensures that life insurance will remain a relevant and viable tool not only for the death of our clients but for the enjoyment during their lives as well.

John “Hutch” Hutchinson, ChFC®, CLU®, AEP®, EA
Founder of BankingTruths.com

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