Low interest rates present a persistent headwind for insurers’ profitability. How firms meet that challenge has consequences for their products and portfolios, as outlined in commentary by DBRS Morningstar on Thursday.
Ongoing low rates make it difficult for insurers to generate sufficient income from their investment portfolios, which largely comprise investment-grade fixed income, the rating agency said.
“Life insurers are particularly vulnerable to declining interest rates due to the long-term nature of the business,” said Komal Rizvi, vice president of insurance at DBRS Morningstar, in a release.
Insurers most affected are those with high proportions of long-dated products with high guarantees.
“As older bonds mature, it becomes more difficult for insurers to find another instrument that has the appropriate duration, risk characteristics and the necessary yield to replace [them],” the DBRS commentary said.
It also noted that, with continuing low rates, pricing for policies issued in earlier years may prove inadequate. Yet, insurers can’t easily change pricing once a product is issued.
In Canada, the pricing problem “explains the increasing number of insurers offering participating whole life products,” DBRS said, “as these products allow insurers the flexibility to reduce dividend payments if lower interest rates no longer make it possible to offer the higher dividend rates common in earlier years.”
Another challenge is that policyholders with older policies that have gained in value due to low rates and that may have generous embedded guarantees may be less likely to lapse them. Insurers price in a certain level of lapses in their actuarial assumptions, the report said.
Insurers’ responses to the risk of low rates have included repositioning their product mixes, reducing the level of guarantees offered and refraining from offering certain products, such as long-term care products — though such products are in high demand by consumers.
Further responses by insurers to meet the challenges of low rates could take a riskier turn.
“In the future, we may see insurers increase their debt levels as financing charges remain low, or invest in riskier assets in an attempt to find yield, although this has not occurred yet to any large extent,” Rizvi said in the release.
While increased debt levels at low rates could be useful to invest in operations, for example, the staggering and maturity dates of individual issuances becomes more important, as does liquidity, DBRS said.
Regarding riskier assets, capital requirements for high-quality fixed income are generally less onerous than for other asset classes, which will likely “dissuade insurers from changing their investment portfolios in a meaningful way,” the commentary said.
Instead, insurers may shift the composition of their fixed income allocations, away from federal government bonds to lower-rated corporates or other alternatives.
Other potential industry developments are increased competition in lower-risk business lines such as group insurance, as well as an increased trend into non-insurance businesses.
Such moves may introduce new risks for insurers, however.
“While diversification away from some insurance products can be helpful in maintaining a low-risk product profile, a diversion of focus away from the core insurance business to ancillary businesses that an insurer may not be experienced in poses its own set of risks and challenges,” DBRS said.