The low interest rate environment has had a relatively negligible effect on life insurers so far, according Moody’s. That, however, will change if rates continue to hover near historic lows through 2015 as has been indicated by the Federal Reserve.
The low interest rate environment, which is rapidly becoming the new normal, was the topic of a recent report released by Moody’s titled, “Interest Rates Low, Low, Low: Are US Life Insurers Concerned Enough?”
The subjective nature of the question leaves room for debate but as Moody’s found through their 2012-2016 GAAP earnings projections, where they surveyed 20 life insurers under different scenarios, respondents were able to project earnings that were “relatively insensitive to low interest rates.”
Under the scenario of low interest rates coupled with low equity returns, insurers responded that their median projected annual earnings growth was 6.2 percent.
Moody’s feels that life insurers may be more optimistic than practical given that that accounting standards defer the recognition of low interest rates; their strong earnings projection under an adverse macroeconomic environment and their past underestimation of tail risks, namely, from long term care insurance and variable annuity with guaranteed benefits exposure.
In order to cope with new environment, life insurers have lowered their crediting rates in order to maintain interest margins, raised prices on new business and discontinued interest-sensitive products. Moody’s does not find these actions completely ameliorative however, and the rating agency augurs a widening gap between earned interest rates and interest rates implicit in pricing and assumptions. Moody’s sees a trend towards higher earnings charges and capital hits from spread compression.
Life insurers have been able to withstand the low interest rate environment fairly well but Moody’s warns that the longer rates stay low some of the products that life insurers offer can be adversely impacted. Namely, long term care will have to be re-priced (the increase will require regulatory approval), variable annuities with minimum income and withdrawal benefit riders will be re-priced or discontinued (higher reserves and hedging costs will also be impacted) and fixed annuities will be squeezed as companies hit contractual margins. Moody’s notes that life insurers' “aggressive product management” has worked to mollify the impact that the low interest rate environment has had.
Moody’s warns that as companies’ investment portfolios earning the higher rates of former times are shrinking, and credit rates get closer to contractual minimum interest rates, profitability will be affected and writedowns could be required.