Due to the dropping prices of oil worldwide, oil-exporting countries such as Canada are at risk to experience inflation and negative financial growth. In an attempt to prevent this from happening in the country, the Bank of Canada recently cut its interest rates by 0.25 percent. According to the Bank of Canada, this move was made in order to counter inflation and maintain financial stability.
Cutting interest rates may seem beneficial at first, however, the life insurance industry is one of several financial sectors that will be negatively affected by lowered national interest rates. According to a new report by Moody’s Investor Service, many life insurers face losses and capital declines if interest rates continue to stay low in the foreseeable future.
Remember, most life insurers make a profit by investing the premiums they receive from clients into low-risk investments that rely on interest payouts such as bonds and segregated funds. Low interest rates means that these investments turn lower payouts as they mature. As a result, the death benefit for a life insurance policy can turn out to exceed the total value of the premiums collected by the life insurer. When this occurs, the insurer has to take a loss on the policy. If this happens enough times, the insurer’s business has a chance of becoming jeopardized, especially if it’s a smaller business.
Moody’s Investor Service expects the above scenario to play out more frequently if interest rates remain as low as expected.
“We expect global interest rates to remain low by historical standards, so new money and maturing assets will be reinvested at yields that are lower than current portfolio yields. As a result, life insurers’ investment returns will continue to decline for many years,” says Benjamin Serra, a Moody’s Senior Credit Officer and co-author of the report.
Insurers can raise the price of current premiums to offset this problem. But, many existing clients prevent this from happening by opting for a life insurance policy with locked premium rates. Therefore, insurers that offer these life insurance policies with guaranteed premium rates are most at risk.
Other factors that determine a life insurer’s vulnerability to declining insurance rates include their business mix, the insurer’s ability to share any possible losses with current and future policyholders, and the duration gap between the maturation of their assets and liabilities.
According to Moody’s report, insurers located in markets where the investment returns are already below or close to guaranteed rates and the duration gap between the maturation of assets and liabilities is high are most at risk of facing losses.
Low interest rate risk markets include countries like Germany, the Netherlands, Taiwan and Norway. Other countries such as Australia, Ireland, Brazil, Mexico and the UK are considered to be the least exposed to low interest rate risk.
Low interest rates also have the potential to hurt an insurer’s business indirectly by leading to a loss of potential sales.
For example, an insurer could attempt to prevent any potential losses due to lower interest rates by offering fewer life insurance products with guaranteed premium rates. However, these products are popular with consumers. If a certain insurer no longer offers these products, those customers can go elsewhere and that insurer could risk losing the sale entirely. This puts the insurer in a tough situation, where they face a certain degree of risk regardless of what they decide to do.
Many life insurers have already started trying to make some changes to their business in an effort to counter low interest rates risk in other ways. Some of these ideas include lowering credited rates on in-force policies, reducing guarantees on new business and hedging interest rate risk through derivatives.
Other life insurance carriers have changed their business mix and expanded into other areas of the insurance industry by diversifying their list of products offered to customers.
At the end of the day, it’s important to understand that lowered interest rates in Canada are a major challenge for life insurers. Different strategies and tactics need to be looked at if insurers wish to overcome this latest obstacle to affect the industry.
