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Investing in a High Interest Rate Environment: Everything Insurers Need To Know

Life Insurance and Annuities
by Stephanie Crownhart
Learn how high interest rates create both positive and negative effects for insurers.
Learn how high interest rates create both positive and negative effects for insurers.

Interest rates and insurance share a deep connection, and any change in rate can affect an insurance company's assets in multiple ways. Still, insurers are in a good position to profit during a rate hike with the right investment methodology in place.

While a high interest rate environment can bring a level of uncertainty for businesses and investors, it's important to know how assets like stocks and bonds react and where capital will perform best.

In this blog, we're walking through the characteristics of a high interest rate environment, discussing how they affect certain insurance products, and how to optimize returns and manage risks during these times.

How High Interest Environments Affect Insurers' Investing Methodologies

Historically, moderately rising interest rates are good for insurance companies. However, rising rates coupled with inflation can affect insurers differently.

When interest rates are high, insurance companies may experience both positive and negative effects and should be prepared to adjust their investment methodologies accordingly.

Positive Effects of High Interest Rates for Insurers

Higher interest rates can lead to increased investment income. When interest rates are elevated, yields on investments are also higher, contributing to greater returns on corporate bonds for bond investors.

Life insurers, in particular, stand to gain in these environments, as they're often expected to earn better spreads over the cost of liabilities.

Negative Effects of High Interest Rates for Insurers

Conversely, the opportunity cost of holding on to bonds for an extended period also rises in a high interest rate environment, which means insurance companies are more likely to miss out on a better investment.

The good news is that insurers can adjust their investment portfolios and methodologies to optimize returns and manage risks in response to rising interest rates.

As an example, bond investors might allocate more of their investments to fixed-income securities to take advantage of the higher yield.

How High Interest Rates Affect Stocks, Bonds and Insurance Products

A rising interest rate environment affects stocks and bonds differently. It's crucial to understand the effects higher rates have on the stock and bond market to carry out effective financial planning and develop an investment strategy that works for the business:

  • Lower bond prices: Interest rates and bonds typically move in opposite directions. So, when interest rates rise, existing bond prices fall. This is because when new bonds are issued with higher interest rates, existing bonds with lower rates become less attractive to investors. Prices of existing bonds fall to make them more competitive with the newly issued, higher-yield bonds. As interest rates rise, the opportunity cost of retaining long-term bonds at lower rates over an extended period increases for many insurance companies.
  • Reduced stock valuations: The valuation of future earnings in stock analysis relies on factors such as interest rates and inflation expectations. When investors foresee an increase in future interest rates, it decreases the present value of these future earnings. Consequently, stock prices often come under downward pressure.

When higher interest rates cause changes in the financial landscape, it affects all forms of investments —  including life insurance. As such, insurers must plan the pricing of their life insurance products accordingly. This will ensure that they're making strategic decisions that align with their business goals and are in the best interest of potential future policyholders.

How High Interest Rates Affect Life Insurance Products

In a lot of cases, a rising interest rate environment can make some life insurance products more attractive. Consider this example for fixed universal life policies:

Insurance companies often invest the premiums they receive from policyholders in fixed-income securities. In a high-interest-rate environment, the yields on these investments are typically higher, leading to increased investment income for the insurance company.

Furthermore, fixed universal life policies usually come with a guaranteed interest rate on the cash value. In a high-interest-rate environment, these policies may be more attractive to consumers seeking stable and guaranteed returns.

Variable universal life insurance policies allow policyholders to invest in a range of sub-accounts, including equities and fixed-income instruments. In a high interest rate environment, the fixed-income component of the portfolio may yield higher returns, positively impacting the overall investment performance of the insurance company.

To maximize value in a rising rate environment, it's paramount that products are priced appropriately.

Optimize Returns and Manage Risk In High Interest Rate Environments

In a high interest rate environment, actuaries at Lewis & Ellis can help insurance providers:

  • Manage risk.
  • Price insurance products appropriately for optimized returns.
  • Monitor solvency to help meet financial obligations and regulatory requirements.

Don't wait until interest rates rise to develop the right investment strategy; plan ahead to take advantage of rate hikes as soon as they happen. For expert guidance on adjusting for high interest rates, contact Lewis & Ellis today.

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