What Vexes Insurers: S&P Explains

Interest rates are like a tightrope with risks from both increases and decreases for insurers that are not sure footed, according to a new report issued by Standard & Poor’s Corp., New York.

Fortunately, according to the S&P report, “Interest Rate Risk: Why Both Decreases And Increases In Rates Can Vex Insurers,” most insurers have developed enterprise risk management programs to reduce this risk.

The long-term nature of several insurance products and their supporting assets make the insurance sector one of the most interest-rate-sensitive sectors that Standard & Poor's rates,” the rating agency says.

The products at greatest risk for disintermediation are fixed annuities and universal life, according to the report. But companies that sell these products have, for the most part, strong ERM programs, according to the report. However, according to the report, “the risk is still relatively modest in our view, in part because of companies' ability to offset the loss of interest with increased nonguaranteed elements, such as the cost of insurance charges on some products.”
“In a prolonged low interest rate environment, earnings spread compression is the most significant risk. Specifically, investment of premiums and deposits and reinvestment of interest income and returns of principal on maturing fixed-income securities into lower-yielding investments will pressure net investment income over time,” S&P cautions.

The report says that long-term care insurance and individual disability insurance face risks if there is a prolonged low interest rate scenario since these products have long-duration liabilities and a shortage of matching assets which creates significant reinvestment risk for issuers. And, the report explains, for life insurance and annuity product lines, investment income constitutes a significant portion of earnings.

Health insurance, according to S&P, is the least interest sensitive of insurance lines because of the short-term nature of the segment’s liabilities. And property/casualty insurers are not as impacted by interest rate risk, according to the report. “Property/casualty insurance products do not credit interest to the policyholder. In addition, their products do not have significant liquidity-sensitive features, and claimants usually cannot accelerate cash outflows.”