How does the interest rate chosen make a significant difference in investment returns?

The interest rate assumption is usually the most powerful assumption in an illustration due to the compounding impact over many years. Over longer time periods, the power of compounding interest can result in accumulations that differ significantly for two interest rates that differ by only one or two per cent.

 

Examine the graph below. Six interest rates are used to illustrate how an initial investment of $1,000 will grow in the span of thirty years.

 

Note the return on investment after 30 years:

• at an interest rate of 2% the initial investment has grown to a mere $1,800.
• at an interest rate of 6% the initial investment has grown to about $5,750.
• at an interest rate of 8% the initial investment has grown to about $10,060.
• the difference between 8% and 6% - only a 2% difference - is a 75% greater return!

Interest Rate Sensitivity Graph

 

It is very clear that a slight difference in the interest rate will return significantly different gains.

 

Since life insurance policy illustrations cover an extended period of time, often 30 or 40 years or more, it's important to understand the reasonableness of the interest rate assumption used in the illustration. Consequently, how do you determine if the illustrated interest rate is "reasonable"? Should you pick the plan with the highest interest rate illustrated? To find the answers, proceed to the next page.

 

Next page >

 

What are reasonable interest assumptions for Universal Life plans?

 

 

 

Click a link below to jump to another section of the article:

 

What is the purpose of life insurance illustrations?

 

What is a reasonable period of time an illustration should consider?

 

How should I consider interest bonuses?

 

What are reasonable interest assumptions for Whole Life plans?

 

Summary of life insurance traps to avoid.

 

Contact a professional broker for your free consultation.

 

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