12Mar2012

The low interest rate environment: A roundtable discussion with members of the SOA’s Smaller Insurance Company Section – Part 1

In September 2011, the Smaller Insurance Company defined its mission: “to synthesize information for smaller company actuaries.” The section’s focus for this year is the low interest environment. In this roundtable, four Smaller Insurance Company Section members talk about the effects of the low interest rate environment and its effect on the insurance industry. 

Participants:
Robert Guth, Actuary, Everence Association Inc.
Mark Rowley, Vice President, EMC National Life Company
James Thompson, Actuary & Consultant, Central Actuarial Associates
Donald Walker, Director, Life Actuarial Department, Farm Bureau Life of Michigan

1. You formed your team last fall. Why did you decide to form a team based on the low interest rate environment?

Thompson:
The Smaller Insurance Company Section realized that this would be at least a year-long problem. It has many implications.  As year-end asset adequacy analysis approached, we needed to know what to do about our level scenarios.   Should we use mean reversion to a higher Treasury curve?  Would this be acceptable to regulators? But there are other implications.  What if the nonforfeiture rate for life insurance fell below 4%?   What about maintenance of in force blocks?  Product strategies?   Solvency issues?  We resolved to focus on all of these aspects.

Rowley: It is an issue that affects both small and larger insurance companies in so many ways, including but not limited to:

  • having to set up extra reserves in asset adequacy analysis,
  • possible changes in valuation and nonforfeiture interest rates,
  • reduced spreads that put pressure on profitability, and
  • it has an impact what products to offer.

2. On your Dec. 9 webinar, Financial Considerations for Year End, you asked participants what they think will change the low interest rate environment and how soon? What do you think?

Guth: Either economic recovery, inflation, government actions or war will change the environment. It could change in one to 15 years, either slowly at first or maybe suddenly.

Rowley: This is a crystal ball type of question, and we don’t have any certain answers.  We have heard for a long time that interest rates can’t go any lower, and then they go lower again.  A shocking development last fall was when the 10 year treasury rate went from a very low 3% to an extremely low 2% in a matter of weeks.  The prognosticators say that the environment is impacted by the U.S. economy and economies around the world, with a particular eye on current problems in Europe.  Gas prices are also something to watch.

3. What types of issues are associated with low interest rates for insurance companies—is it just an issue for life insurance companies?

Rowley: It is certainly not an issue for just life insurance companies.  Property and casualty insurance companies and other banks and financial institutions are certainly impacted.  The interest rate environment makes some products very unattractive in the marketplace, such as traditional fixed universal life and annuities.  It also makes it hard to pass illustration actuary testing on certain products.

Guth: Insurance companies are impacted by low interest rates because of low investment rates and previous guarantees promised to our policyholders. The NAIC regulatory environment has regulations that never anticipated a five-year treasury below 1% for an extended period, nor a US Treasury that is not AAA. Insurance companies do not have access to the Federal Reserve discount window in a way that banks do.

Walker: Looking at the issues for life insurance companies-

  • Many of the products we sold years ago have very generous interest rate guarantees; what steps do we need to take to assure that we will keep our promises?
  • Other products we sold may not have had quite the same guarantees, but we did illustrate policy values based on higher interest rates being available; how will we manage that situation and how will we communicate with our agents and clients that things may not be quite as rosy as we said they would be?
  • Will we need additional reserves?  How should those reserves be established?  What testing should be done?  How will we communicate this to management and other interested parties, such as regulators and rating agencies?
  • There are important regulatory rates that are tied to bond yield indexes.  These indexes are at historic lows!  What may happen this July, when the maximum statutory reserve rates are recomputed?  What about the maximum nonforfeiture rates?  How will these changes interface with Federal Tax Law (both for tax reserves and for the definition of life insurance)?

Information on these topics is trickling out; we want to gather as much as we can and make sure that it gets to our members.

Thompson: As life insurance actuaries, we are paying attention to life insurance companies.   Life insurance is a long term contract (including annuity payouts).  Obviously it affects the investments the companies make, including those made from premiums paid in the future.  Thus it affects product design.  It affects our illustration certification.   It will affect what types of products we design and sell in our future portfolios.  It affects our asset adequacy tests.  It will affect our own investments.   Also the types of investments policyholders can make may affect whether they will buy insurance products.

Stay tuned for Part 2 of this discussion, which will be posted tomorrow.

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Discussion

One response to "The low interest rate environment: A roundtable discussion with members of the SOA’s Smaller Insurance Company Section – Part 1"

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