The Low Interest Rate Conundrum

Normally, low interest rates portend fortuitous economic and business conditions. Well, these are not normal economic times.

With the Federal Discount Rate mired at .75 percent and little indication from Federal Reserve Chairman Ben Bernanke that this is going to change anytime soon, a host of challenges present themselves to purveyors of interest rate-sensitive products. For starters, with living benefits becoming an increasing part of variable annuity offerings, low interest rates drive up the cost of providing that guarantee. Low interest rates also drive up the cost of dynamic hedging.

Indeed, in a report issued last month, A.M. Best warned that if the rock-bottom rates persist, U.S. life insurers may face a considerable amount of interest rate risk, noting that with Treasury bond yields near historic lows and the equity markets fragile, the issue of whether carriers can continue to generate enough investment income to fund guaranteed policy benefits has become a legitimate concern.

So how can insurers look to mitigate interest rate risk? Much of the solution may reside in the products themselves, says Dana Pedersen, VP and product officer of Phoenix Companies, Inc. Pedersen says that while a low interest rate environment does makes it more difficult to develop annuity products, insurers have options. “It’s really a matter of working with the interest rate environment that you have and trying to pull the different levers within the products to find the right balance,” she tells Insurance Networking News. “There is a variety of ways to do it. Across the indexed annuity space we’ve seen premium bonuses come down, we’ve seen commissions come down. The level of guaranteed income has also come down. These are all changes that are in response to the prevailing low rate environment.”

Another strategy is to build more self-adjusting features into products that ensure that both insurer and client are covered across a variety of economic scenarios. “Building more responsiveness into products is something we are going to see more of in a prevailing low rate environment,” she says.

With premium bonuses and guarantees shrinking, carriers will have to invest in customer-facing technologies to keep products enticing to consumers. For example, Pedersen sees an increasing need to have the technology that will produce in-force illustrations for clients. Moreover, she notes that Phoenix is building out front-end technologies that ease the gathering of client information for the applications and suitability forms by automating populating data fields, thus streamlining the process.  “We are really trying to make the submission process and access to information prior to new issue smoother for the producer.”

Despite the challenges surrounding the rate environment, Pedersen is optimistic, noting demographics are in the industry’s favor if it can produce appealing products. “The demand for guaranteed retirement income is there, regardless of the interest rate environment."

Bill Kenealy is a senior editor for Insurance Networking News.

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