Canadian insurers aren't immune to the effects a low interest rate environment has on business. But the effects are more serious now that in the past. That's according to a recent report by reinsurer Swiss Re.
According to the report, interest rates in Canada have been on a down-trend for the last 30 years, with real rates falling to near zero by 2011 in the wake of the 2008 financial crisis. So, though Canadian insurers are no strangers to low rates, the proportion of interest rate-sensitive products in the market in Canada today is higher than in the past, which creates issues on the profitability side of business, as the cart below illustrates.
Other areas of impact from low interest rates include quarterly reporting and economic valuation since both take interest rate changes into account from the outset. But it's not all bad news.
"The interest rate sensitivity of the Canadian life sector has increased over the past decade," the report noted. "Despite poor post-crisis performance, direct annuity premiums have grown at a compound annual growth rate of 5.6 percent since 2003, faster than the 4.2 percent economic growth in nominal terms over the same period."
Other findings in the report include:
- The interest rate vulnerability of life insurers' portfolios depends on the product mix, which has become more interest rate-sensitive over the past decade.
- Life insurers are especially influenced by low interest rates because they have a higher share of long-term contracts that require increased reserves due to low asset-derived discount rates.
- The best case interest rate scenario for insurers would be a gradual return to "normal,” which is the likely scenario over the next two to three years; though the report stresses that insurers must plan for a range of interest rate scenarios.
- Policies could be made more flexible through adjustable pricing that reflects market developments. As such, product re-design offers insurers the most options to manage interest rate sensitivity going forward.
In terms of the future, Swiss Re Economic Research & Consulting sees interest rates in Canada rising slowly over the next two to three years, with the yield on the 1-year Canadian government bond forecasted to reach 4.5 percent in 2017.