A risk-free discount rate proposal developed by the Financial Accounting Standards Board (FASB) could discourage life insurers from selling products such as single-premium immediate annuities.
Donald Doran, a partner in the insurance practice at PricewaterhouseCoopers L.L.P., New York, has discussed that possibility in comments on a major FASB insurance accounting standards proposal.
FASB, Norwalk, Conn., is continuing to seek comments on the proposal and revise it. But, in theory, if FASB went ahead with calling for use of the risk-free discount rates, the pricing of insurance products could change quite a bit, Doran says.
In the United States, risk-free discount rate figures are usually based on yields on U.S. Treasury bonds or notes. Today, Doran says, insurers base the interest rates used in pricing on a portion of expected investment yields.
The proposed change “potentially could cause companies to increase prices or stop selling investment spread products such as single-premium immediate annuities, or any long tail product where the investment spread is a large part of the pricing, in order to avoid a loss on selling the product, Doran says.
Insurers also could shy away from covering products that are sensitive to changes in interest rates or stock prices, Doran says.
“These products will need to have sophisticated hedging programs in order to avoid the volatility in results from re-measuring insurance liabilities for current market conditions,” Doran says. “The cost of these hedging programs could affect the profitability of the products.”