Higher rates could pose problems for life insurers

Persistent, low interest rates have wreaked havoc on many life insurers' bottom lines in the last few years, but now that rates are starting to rise, that could create a different type of concern for these companies. As such, many may want to assess all of their investment options before making any major decisions.

With interest rates ticking upward in recent months, there may be cause for celebration among many life insurers. Not all increases may be created equal, however, according to a report from Fitch Ratings. While slow and steady increments would be welcomed going forward, large increases could increase volatility in the market and potentially set insurers up for a fall.

Fitch believes that the best possible scenario in this regard is reasonable increases of about 1 percentage point per year, which would help life insurers with exposure across a large number of products. This would likely also serve to create positive movement for investment income and margins. Through the first six months of this year, rates have climbed about 70 basis points, and that's more or less in the range of helpful developments.

However, if interest rates jumped up suddenly by 500 basis points, there could be major issues, the report said. Many insurers might suffer investment losses as a consequence of this kind of rate change, particularly those forced to sell assets to cover the costs of paying out cash surrenders to policyholders. On the other hand, if interest rates stay more or less level for the next few years, insurers could see some issues going forward, at least in terms of earnings growth being somewhat restrained.

A gradual increase in interest yield rates should be beneficial for the life insurance industry. However, a very rapid and uncontrolled spike in interest rates could be harmful to insurers, particularly those who have invested in “long duration” securities to achieve a higher yield. As interest rates rise, market values of already purchased fixed income securities tend to fall. Although insurers generally report statutory values on an amortized cost basis, should surrenders rise as policyholders follow yield, a rapid rise in interest rates could force some insurers to sell securities at a loss. It will be interesting to follow interest rates as the U.S. Treasury considers cutting back on its purchases of mortgage-backed securities. The expected cut back is generally viewed to push interest rates higher.