If you have been watching the period of low interest rates, ergo a zero-rate policy, for very long there is a good chance that you have felt the squeeze on how to earn interest on your money. The problem is that this is also true for your bank and your brokerage firm, and ultimately that profit squeeze may drive up commissions and fees as they have to generate more in profits. Most consumers and investors alike have not figured out how the low-rate (or no-rate) policy by the Federal Reserve is going to impact the pricing of life insurance policies. The long and short of this matter: not positively.
Moody's Investor Service has finally taken a gander at this and the summary is stark: "US life insurers will be vulnerable to the impact of continued low interest rates on earnings…"
The report from Moody's is a new special comment called "Interest Rates Low, Low, Low: Are US Life Insurers Concerned Enough?" As you can tell, there is going to be some serious concern if this no-rate policy lasts forever. Because this is of keen interest and something we have been monitoring for over a year, 24/7 Wall St. has added in color on this issue on low-rates and the impact of future life insurance policies.
Moody's summarized 20 life insurers' responses to the rating agency's survey of 2012 to 2016 GAAP earnings projections under several scenarios. This survey included a scenario of low interest rates and low equity returns.
24/7 Wall St. has another issue to consider here. What the public have to be concerned about is that the end game has only one rational outcome: if these insurers want to sell new life insurance policies, the low-rate environment is going to drive your monthly premiums higher and higher for future insurance policies. Modern actuaries and financial planners have a tough pricing structure when the risk-free rate of return is zero and when there is no discount rate to consider in the time value of money analysis.
Neil Strauss, a Moody's Vice President and Senior Credit Officer said, "Our surveyed insurers responded with projected earnings that are relatively insensitive to low interest rates. But we believe that if rates remain at current levels beyond 2015, there would be significant earnings charges and loss of capital, leading to rating pressure."
Sorry to keep adding in concern here but this is something of importance to us at 24/7 Wall St. for our readers. Ask yourself this question… What will insurers do to avoid rating pressure? Most likely they will do what insurers do best: price hikes on future policies!
Moody's has noted so far that low rates have had a relatively modest impact on US life insurers so far. Moody's also said that this is "as companies have lowered crediting rates to maintain interest margins, raised prices on new business and discontinued interest-sensitive products. But as the gap widens between earned interest rates and interest rates implicit in pricing and reserving assumptions, Moody's sees a trend toward higher earnings charges and capital hits from spread compression."
Have you tried to buy an annuity or helped a family member try to buy an annuity lately? The rates are pretty pathetic, even if they have a higher above-market teaser rate up front. The point that really stands out to us brought up by Moody's is on these longer-duration portfolios such as life insurance. Moody's stated,
The report also notes that until now companies' long duration investment portfolios with gradual turnover have muted the effect of low reinvestment rates, and current accounting practices have delayed recognition of meaningful impacts from low interest rates. However, as insurers' investment portfolios earning the higher rates of yesteryear are shrinking and crediting rates inch closer to contractual minimum interest rates, profitability will be pressured and accounting writedowns may be required….Moody's believes that insurers may be optimistic in their projections given the accounting flexibility allowing non immediate recognition of low interest rates and underestimation of the impacts of adverse macroeconomic environments and tail risk.
Our take is that Moody's is addressing a very important issue going forward. However, our fear is that the industry has not adequately braced for the future of when the tide finally turns. The financial market institutions and participants have been told over and over not to expect any serious rate hikes until late in 2014 our out into 2015. Now Ben Bernanke and friends have set thresholds of 6.5% unemployment with a belief that a sustained 2.5% or higher inflation rate will be seen as the guideline for interest rates.
It seems unlikely that Ben Bernanke will go into another term as Chairman of the Federal Reserve, but… A new chairman means the potentiality of a new policy. Imagine if the hawkish Jeff Lacker or someone like him gets to be the Fed-head. The 30-year Treasury Bond has seen its yield rise from about 2.7% to almost 3.0% over the last month. Our concern is not just a protracted low-rate environment as Moody's has dealt with in this report. Our real concern is what happens if rates start to rise rapidly against these insurers.
The good news is that interest rates are not likely to rise 100 basis points overnight, barring any credit shock of course. But what if they did? If the entire yield curve were to rise by 1 full point in an instant the impact to long-bond portfolios would be devastating. What would be even more devastating is if the 30-year Treasury and the rest of the yield curve rises by something like 200 basis points over the course of a year.
After talking with a bond broker, the adjusted duration of the 30-year Treasury is currently above 19. If rates rise 100 basis points in very short order, that implies that the face value of a 30-year Treasury Bond would be down close to 19% from the equivalent of a Par value today for the first 100 basis point rise. Insurers often have positions hedged with risk, but most insurers cannot and do not hedge all of the interest rate risk in their portfolios because it is too expensive.
The low-rate and no-rate policies of today are only going to drive the prices of life insurance higher, even for those who are in great health. It will be even worse when interest rates rise and begin to hit the value of the existing portfolios of life insurance portfolios. That will drive future life insurance rates even higher.
Stay tuned to this topic. 24/7 Wall St. will be covering it in far more detail in 2013 and beyond. Your money matters!
JON C. OGG
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