Reinsurance News

Interest rate increases to support investment income long-term: Swiss Re Institute

8th October 2018 - Author: Charlie Wood

While insurers need to improve their underwriting results if they are to redress current profitability shortfalls and anticipated near-term shareholder equity decline, rising interest rates are expected to paint a brighter future and support investment income long-term, according to a report by the Swiss Re institute.

Swiss Re InstituteSwiss Re expects U.S rates to continue moving up slowly, with a total of four Fed hikes in 2018, followed by two in 2019. Meanwhile, the European Central Bank says its expansionary monetary policy will end in December.

The Bank of Japan, however, is set to maintain its ultra-loose policy stance. With these monetary policy developments, Swiss Re expects long-bond yields to rise modestly also, though not to pre-financial crisis levels.

The closing of the global output gap, continued at-or-above trend growth and firming inflation will support this development.

Slowly-rising rates provide a boost, states the report, particularly for long-term savings products with guarantees, which have been under significant pressure over the past decade. However, higher rates are not an instant remedy.

Stratumn, by SIA Partners

Life companies roll over about 10% of their investment portfolios every year, so this rise has only a marginal and lagged impact on overall portfolio yield.

Depending on a life company’s portfolio duration and levels of coupon on current holdings, the portfolio yield may still continue to decline for a number of years, as historical holdings that drop out of the portfolio continue to have a higher coupon than newly-bought bonds.

Under accounting regimes with book value liabilities, falling bond values lead first to the unwinding of previously accumulated unrealised gains and then a build-up of unrealised losses, and a significant reduction in the accounting estimate of shareholders’ equity.

The report states that if interest rates spike suddenly, in addition to a decline in accounting capital, some life insurers may experience increased surrenders on savings business with lower guarantees, forcing them to realise losses on sales of fixed income assets. Lapse risk is a challenge to manage because of the complexities involved in hedging it.

Over a longer horizon, the boost to investment income from rising interest rates will more than offset the negative accounting impact on equity.

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