Challenges Albeit Low Interest Rate

The possible effects of changes in life insurers’ interest rate assumptions is one of the question marks looming over the industry. Established & major players have already slashed the interest rate assumptions they use to run their businesses.

Interest rate assumptions matter to life insurers partly because the reserves they hold, and invest, to support long-term life, disability insurance, long-term care insurance (LTCI) and annuity obligations are enormous relative to the size of their net income.

Even small changes in rate assumptions may require them to top off reserves. Shifts of cash into reserves that are small relative to the size of the reserves may look huge relative to the size of an insurer’s typical earnings. The lower the interest rate assumptions, the higher prices for new life, annuity, disability and LTCI products are likely to be, and the skimpier the benefits guarantees are likely to be.

Bondholders’ Pay Cut - big life insurers look as if they’re getting a manageable number of COVID-19-related life insurance claims, with claim costs well below stress-test levels. For now, at least, life insurers’ portfolios of corporate bonds, mortgages and mortgage-backed securities look fine.

However life insurers hold trillions of dollars in high-quality corporate bonds, Moody’s Seasoned AAA Corporate Bond Yield chart shows that the yield available from the very highest rated corporate bonds has dropped to 2.3%. That’s down from 3% at the started of the year, and down from a level over 3.6% for most of the past five years.

S&P’s own S&P 500 10+ Year Investment Grade Corporate Bond Index shows that the average yield to maturity for the basket of high-quality corporate bonds it tracks stood at 2.93% Wednesday. That was down from about 3.6% a year ago.

Bond yields represent just one component of what life insurers can earn on their investment portfolios, but a big component. For a life insurer, the situation is comparable to what might happen to an agent who collects commissions and asset-based fees, and who sees the asset-based fee revenue cut about 20%.

Big life insurers’ long-term rate assumptions for 10-year U.S. Treasuries range from 2.25% to 5%, with many with assumptions clustering between 3% and 4%. The actual 10-year Treasury rate is now 0.649%.

The Stock Picker Perspective - Several securities analysts are painting a similar picture. In a commentary - they describe the corner of the life industry they follow as a “paragon of resilience.’ Results held up to challenging conditions significantly better than expected, both from an earnings and capital perspective. The albatross around the neck of the industry remains persistently low interest rates.”

Although low rates are a headache for life insurers, low-rate phobia has already hurt life insurers’ stock prices. Because life insurers’ stock prices already reflect worries about low rates, some life insurance company stocks have the potential to do much better than expected, especially if rates do go up more than some life insurers and life industry watchers fear, the analysts write.