When it comes to mitigating financial risk, insurers are rightly vigilant against sudden economic swings that could enervate their investment portfolios. This seems especially prudent given the events of the past two years.
However, a less dramatic but equally dangerous risk may come from something mundane—interest rates. New York-based Standard & Poor's Ratings Services (S&P) has published an article, “Interest Rate Risk: Why Both Decreases And Increases In Rates Can Vex Insurers,” that analyzes the issue.
“Interest rates are at historically low levels but can rise or fall quickly,” the paper states. “Fortunately, most insurance companies learned from past missteps and have developed enterprise risk management (ERM) programs that generally have mitigated much of the risk and have tempered our concern from a ratings perspective.”
Nonetheless, S&P stresses that both low interest rates and high interest rates have a potential credit impact on insurers.
“Although low rates would pressure interest margins on spread-based products, a spike in rates would heighten disintermediation risk,” the reports states.
While both scenarios will present challenges, prolonged low rates may be more troublesome considering the products sold by many life insurers.
“Interest-sensitive products, particularly commoditized fixed-rate deferred annuities, have become an increasingly significant proportion of many life insurers' business mix, supplanting less interest sensitive products, such as participating whole life insurance,” the report states. “The growth of variable annuities with death and living benefit riders has increased insurers' exposures to another form of interest rate risk embedded in these options. The recent decline in interest rates has highlighted this exposure when some companies did not fully hedge it.”
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Corrected November 16, 2010 at 10:17AM: yes