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What if rates rise?

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Buying a private long-term care insurance (LTCI) may be a simple, cheap, responsible way for a consumer to bet on the possibility that U.S. interest rates could climb.

Supporting an LTCI unit could also be a way for a life insurer to allocate some assets toward businesses that could do well if rates return to more normal levels.

Tom Riekse Jr., managing general principal at LTCI Partners, an LTCI distributor, talked about the  LTCI community’s dream — that rates could begin to rise in a gradual, yield-enhancing, helpful way — in a recent interview about the state of the LTCI market.

“From our perspective, things have been going well,” Riekse said. 

Most of the carriers that are still in the market, seem to be staying in the market, and the remaining carriers are eager for LTCI Partners to send them business, Riekse said.I

“They’re planning for growth,” Riekse said.

One reason the LTCI carriers are planning for growth is a sense of optimism about rates, Riekse said.

Interest rates are important to LTCI operations because writers of LTCI coverage must be prepared to take premium payments from policyholders who might not file claims for decades, and they must be prepared to pay streams of benefits that could last for years. If they sell policies that offer lifetime benefits streams, they might have to fund benefits streams that could last a decade, or even longer.

LTCI carriers count on getting much of their profit from the difference between premiums paid in and benefits paid out, but they also hope they’ll profit from the interest earnings on invested assets.

State insurance regulators encourage insurers to invest assets in bonds and other instruments generally regarded as safe, and insurers get more respect from regulators and rating agencies when they focus on government bonds and the highest rated corporate bonds rather than bonds issued by lower-rated issuers.

The lower-rated issuers — including many well-known but young or somewhat erratic companies — pay a higher rate, and that rate tends to reflect the reputation of the issuer more than ups and downs in overall interest rates. But regulators and rating analysts worry the issuers will stop keeping up their debt payments.

Since world lenders reacted to the popping of the early 2000s credit bubble by hiding their capital in financial bomb shelters, the Federal Reserve System and other central banks have tried to fill the vacuum left by the vanishing capital by keeping interest rates very low.

Rates on 10-year U.S. Treasury notes stayed under 2 percent for the last six months of 2012, and mortgage interest rates for high-rated borrowers were 3.5 percent.

For awhile, life insurers tried to downplay the effects the low rates would have on their LTCI operations and other yield-dependent operations, such as long-term disability insurance operations and annuity operations, by emphasizing that they invested in such a way that they could easily cope with short-term drops in interest rates. But it is now more than five years since the summer of 2007.

Neil Strauss, a credit analyst at Moody’s Investors Service, recently observed in a commentary that, “U.S. life insurers will be vulnerable to the impact of continued low interest rates on earnings.”

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Life insurers could be especially vulnerable if rates stay at current levels beyond 2015, as strategies based on buffers built up when rates were higher expire, Strauss said.

Some observers say low rates could linger for years because Federal Reserve Chairman Ben Bernanke and colleagues on the Federal Reserve Board see keeping rates low as a way to help borrowers, encourage investors to consider providing money for the riskier individuals and businesses that really need the cash, and hold down the U.S. Treasury’s interest payments.

Economists argue that the central bank of a big, rich country can keep interest rates as low as it wants as long as investors, consumers and sellers of merchandise express their confidence in a country’s currency by keeping that country’s inflation rate low.

The inflation rate has only been about 2.5 percent, and the damage raising rates could do far outweigh any theoretical benefits, some argue.

Some economists, such as Paul Krugman, say Congress and the Fed have been too tightfisted.

Other commentators, such as Peter Schiff of Euro Pacific Capital, have suggested that the U.S. government has understated the inflation rate, and that there is far more pent-up price increase pressure than many acknowledge.

Schiff said health care and publication subscription prices are just two examples of goods with prices that have increased much faster than the official government inflation rate.

When foreign central banks stop pumping their surpluses into U.S. Treasuries, “bond prices will fall, yields will climb, and a tidal wave of dollars will wash up on American shores, drowning consumers in a sea of inflation,” Schiff predicts.

Economists at real estate agent and mortgage banker groups — groups representing businesses that would like to see rates stay low — are predicting that rates could rise considerably by the end of the year.

The Mortgage Bankers Association (MBA), for example, is saying that the rate situation could change quickly when the Fed stops pumping $40 billion of cash into the financial system each month through the “Quantitative Easing 3″program. 

“With the total volume of debt holdings on the Fed’s balance sheet expected to approach $4 trillion by the end of 2013, it remains to be seen how sensitive rates will be when the Fed does begin to exit the market, and it is possible that rates could increase quite sharply when the day comes,” MBA economists say.

At LTCI Partners, Riekse acknowledged that producers selling LTCI insurance  will have a more challenging time communicating with consumers, now that most insurers have had to push through rate increases.

But most LTCI carriers have done a good job of paying claims, and Medicaid and Medicare have credibility problems of their own, Riekse said.

“Who do you trust?” Riekse asked. “”There’s not a lot of trust there right now.”

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