Risk Management Helps Handle Low Interest Rates

Life insurers have taken steps to manage today’s historically low interest rates, but companies must also be prepared in case the low interest rate environment continues for several more years, A.M. Best Co. analysts said.

“It’s a manageable risk, but the key concern is the duration of the period,” said Rosemarie Mirabella, managing senior financial analyst at A.M. Best. “We think it’s a manageable short-term trend, but are concerned that if the trend continued for five to 10 years, it would become much more problematic.”

“Insurers overall have been adjusting reasonably well to the environment, nonetheless, it is a challenging environment,” Mirabella said during a webinar on “The Impact of Low Interest Rates on Life and Annuity Insurers.”

Risk management can play an important role in how companies prepare for different scenarios, said Ken Frino, group vice president, of A.M. Best’s life/health rating division.

“For life insurance companies, both assets and liabilities are heavily exposed to interest rate movements,” Frino said.

Before the financial crisis of 2008, there was almost an “arms race” with companies trying to top each other by offering products with richer and richer benefits, he said.

“Going back to 2008, companies stepped up their risk management practices and changed the benefit designs on products, and looked at not competing as greatly on products and the richness of benefits,” Frino said. “They are continuing to gradually tweak product design, and products aren’t anywhere near where they were pre-crisis.”

Mirabella said one possible way companies can offset low interest rates is by diversifying its products. “The better the diversification, the better the risk management,” Mirabella said. Companies with diversified books have less overall exposure to interest rate risk if they have balanced their sensitive lines with non-interest-sensitive lines, she noted.

Also, she said companies are trying to reprice their existing books to the extent that they can, which can include raising fees, lowering guarantees if possible, and doing some additional hedging.

The products that could be impacted the most by low interest rates are universal life products with secondary guarantees; variable annuities with guarantees; traditional fixed annuities; long-term care and long-term disability, Frino said.

“But the near-term impact is not as great as you would think. It’s going to be a slow gradual decrease,” he said.

George Hansen, actuary and managing senior financial analyst at A.M. Best, said he expects companies to focus on reserves.

“Companies will hold additional reserves. We’ll see reserves impacted, especially those for longer duration products as margins are getting squeezed,” Hansen said.

The 10-year Treasury bond has fallen from 4% to about 2% in yield. Despite the decline in credit quality of U.S. debt — Standard & Poor’s decision to downgrade the U.S. long-term debt rating to AA+ from AAA — the yield on the benchmark 10-year Treasury note has dipped to historic lows as investors have flocked to the perceived safety of debt from the U.S. government, which has never defaulted on its obligations. Yields move inversely to prices, so the higher the demand, the lower the yield. Insurers are big buyers of Treasuries because of their safety and liquidity (Best’s News Service, Sept. 9, 2011).

A.M. Best considered the implication of a possible further sovereign debt downgrade, and ran a stress test through Best’s Capital Adequacy Ratios.

“We looked at the worst possible scenario, and stressed the companies,” Frino said. “For both life and property/casualty companies, we saw maybe 40% of companies fell below BCAR guidelines. We went to each company on a case-by-case basis to see if there was any mitigating factors.”

“What we found is companies were really more concerned about the economy,” Hansen said.

A.M. Best said it would continue to keep an eye on the interest rate environment.

“We’ll maintain a close dialogue with our companies [about] their books, the risks embedded in those books, and what they are doing to mitigate that,” said Mirabella.

To listen to the full webinar, visit http://www3.ambest.com/conferences/events/ViewEvent.aspx?event=WEB140

(By Meg Green, senior associate editor, BestWeek: Meg.Green@ambest.com)