Insurers will be challenged to maintain margins, Dickson says

Prolonged low interest rates will harm life insurers: Fitch

“Clearly, we have entered a phase of the ‘new normal’ in financial circles,” she said, with, very low interest rates, coupled with higher market volatility and closer correlations. “Insurance companies must be aware that economic conditions are such that resulting future returns, in both market and insurance risks, may differ greatly from today’s pricing assumptions,” she stressed.

“If low interest rates continue, as many expect they will, they are a game changer. Even if they do not stay at current low levels, recent experience has once again driven home the point that life insurance companies must not forget the long-term nature of the contracts they write,” she added.

“It is encouraging that many life insurers are re-examining their product strategies and avoiding issuing new products with unsustainable long-term guarantees. Ironically, we may be seeing a return to traditional product offerings, such as participating whole life with guarantees based on very low interest rates and conservative mortality, lapse, and expense assumptions,” she noted.

From a regulatory perspective, OSFI wants to ensure that life insurers are maintaining healthy solvency ratios and still delivering on their promises to policyholders, Dickson said. “If insurers are moving risk from their balance sheets onto policyholders, policyholders need to understand the risks they are assuming – we would not want to see a repeat of the vanishing premium events of the early 1990s,” she added.

And, she said that OSFI is concerned that a few life insurers “may not be moving quickly enough to recognize that a change in strategy is also required. Life insurers need to start making changes to their product portfolios today to mitigate the grading of these low interest rates into the ultimate reinvestment rate to value long term insurance liabilities.”

Additionally, Dickson stressed that the insurance industry can learn from the experience of bankers over the past few years. For one, she noted that OSFI now sees the role of the chief risk officer “as being of primary importance” to both banks and insurers. “The first line of defence is the business itself and it must own the risk in its operations,” she said. “Strengthening the role of the CRO is a significant change for some life insurers, but a necessary one.”

She said that the process of stress testing the insurance industry also revealed weaknesses “in the operating capacity of companies” to provide data for those tests in a timely manner. “We have had discussions with industry representatives to review these concerns and are in the process of making changes to the reporting requirements of the 2012 stress test,” she said.

In an environment of evolving capital requirement, she said that insurers need to be allocating the right economic capital to the right risks. And, she noted, that the move to International Financial Reporting Standards may create “a fair degree of upheaval on the balance sheets and income statements of life insurers.”

“While many may view this as costly regulatory burden, unfortunately we have all seen the costs associated with lax regulation and supervision,” she added.