LTD Carriers Hope Interest Rates Go Up And Stay Up

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U.S. interest rates are starting to creep up. And while that news may be hard on home buyers, it should be good for long term disability insurers, experts say.

A carrier that writes LTD policies earmarks reserves for each claim. The carrier invests the reserves in medium-term, investment-grade corporate debt. Interest earnings help support the benefit payments.

If carriers can assume that they will earn high rates of return on claim reserves, they can put in relatively small amounts of cash today.

“When interest rates are low, [the carriers] have to hold a higher reserve,” says Dan Skwire, a consulting actuary in the Portland, Maine, office of Milliman USA.

Disability insurers also depend on current net investment income to support their operations and boost their profits, says Doug Myer, a senior director in the Chicago office of Fitch Ratings.

Executives at group LTD carriers were feeling good about rates in May 2000, when the Moodys Seasoned AAA Corporate Bond Yield index rose to 8.07%.

But those executives gulped in June, when the index fell to 4.84%. By early September, the index had snapped back up to 5.94%.

In most cases, a carrier can ride out rate fluctuations by basing its LTD rate assumptions on the average rate it is earning on its current LTD investment portfolio.

Because the carrier has bought the notes, bonds and other debt securities in its portfolio over a long period of time, using the portfolios average yield as a benchmark helps smooth out ordinary rate fluctuations, according to Skwire.

Even in the early 1990s, when rates plunged, for LTD insurers, “the average rates didnt change a whole lot,” Skwire says.

In recent years, “rates have been so low for so long that [insurers] are starting to see their portfolio rates come down,” he says.

Some group LTD executives “are surprised at the magnitude of how low rates have been,” Skwire says.

Many LTD carriers stuck to high reserve rate assumptions in 2002 because they thought rates were about to rebound, but rates are still low, and now more carriers are cutting reserve rate assumptions, according to Skwire.

One large LTD carrier reported in July that it cut its LTD reserve discount rate to 4.75%, from 5.25%.

A model regulation adopted by the National Association of Insurance Commissioners, Kansas City, Mo., in 1993 lets disability insurers use a discount rate that is one percentage point lower than the rate for single-premium deferred annuities issued the same year.

But “I dont think anyone that Im aware of would have modeled five years ago that interest rates were going to drop as far as they have,” says Fitchs Myer.

So far, despite the big drop, state regulations and industry business practices have done a good job of protecting group LTD carriers and their customers from the effects of the rate slide, Skwire says.

“I have not downgraded anyone because of the reduction,” Myer notes.


Reproduced from National Underwriter Life & Health/Financial Services Edition, September 19, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.