It’s been a challenging two years for the life insurance industry. It took a 12-percent hit to statutory surplus in 2008 and dealt with liquidity issues in a frozen credit market in 2009. The industry saw a little reprieve in 2010 in terms of assets, credit risks and investments. As a result however, life insurers now face a new and longer-term set of challenges from the lowest interest rates seen since the 1950s, according to a new study—“Life Insurance Industry Investments: Investigating Interest Rate and Sovereign Risk”—by
The study, which analyzes life industry investments and four underwriting market peer groups for the period between 2006-'10, indicates that life insurers response to the credit crisis—increasing cash and sovereign debt holdings—now exposes insurers to other risks, especially in light of Conning’s current expectations about a long-term low interest rate environment.
“The Federal Reserve’s August decision in favor of long-term low interest rates creates a real strategic problem for life insurers,” said Mary Pat Campbell, analyst at Conning Research & Consulting. “In addition to the obvious issue of low returns on an asset portfolio composed primarily of fixed income securities, the low interest rate environment may cause other problems with regulatory requirements and hedging programs. Approaches to dealing with this challenge will require greater sophistication than ever before.”
A more holistic approach may be needed in looking at investment strategy in a low interest rate environment, the study states. Looking at assets by themselves through scenarios will not suffice. Using stochastic models to look at the expected value and variability of outcomes for different investment strategies can provide a more full profile of the risks and returns, Conning says.
“Looking at the industry through 2011 and beyond, the Fed’s commitment to a long, low-rate environment is compounded by the downgrade of U.S. sovereign debt,” said Stephan Christiansen, director of research at Conning. “Insurers must attend to their risk profiles and consider their options. Looking forward, with emerging dynamic capital and risk analysis requirements, our modeling shows that lower interest rates may have particularly pernicious effects on capital charges relating to some asset classes in support of particular annuity products.”
