Close Close

Portfolio > Mutual Funds > Bond Funds

Fitch: Rising interest rates could hurt, too

Your article was successfully shared with the contacts you provided.

Life insurers have been complaining about the effects of record low interest rates on lines of business with obligations with long durations, such as long-term disability (LTD) insurance and long-term care insurance (LTCI) units.

Robert Grossman and other analysts at Fitch Ratings contend in a new “bond bubble” report that a rapid increase in rates — even an increase of just 2 percentage points, to the levels recorded in early 2011 — could also cause problems.

The Federal Reserve Board has tried to buffer banks against the effects of the 2007-2008 credit freeze by holding rates down. The 10-year Treasury rate is now less than 2 percent, down from about 4 percent in late 2008, and down from a range of 5 percent to 7 percent in the 1990s.

Rising rates will help yields on the new bonds and other other new fixed-income debt securities that life insurers buy for their general account portfolios, but rising rates also will decrease the prices that life insurers and other investors can get for the bonds they already hold if they try to sell the bonds before the bonds mature, the analysts wrote in the report.

“The timing, pace, and magnitude of future rate increases is critical to how these risks play out,” the analysts said. “If policymakers are able to manage a phased transition to higher rates, the potential bond bubble could deflate over time, enabling investors to adapt accordingly. A more sudden, severe rate increase would pose greater risks.”

If, for example, interest rates rose 2 percentage points, the market value of a U.S. corporate bond with a solid BBB rating and a 10-year maturity could drop 15 percent, and the market value of an otherwise similar bond with a 30-year maturity could drop 26 percent, the analysts said.

Life insurers have invested about $2.1 trillion in U.S. corporate bonds, and they are the largest investor in that class of bonds.

Life insurers typically try to match duration and expected flow of cash from bonds to their liabilities, to reduce or eliminate the need to sell bonds earlier, and statutory accounting rules usually let them use the original, book value of bonds — not the market value — in risk-based capital calculations, the analysts said.

Higher rates could help insurers with long-duration liabilities, by increasing the discount factor they use to compute the liabilities and decreasing the value of those liabilities, the analysts said.

But some life insurers that have invested more heavily in longer-duration bonds or had problems with asset-liability matching programs could run into problems, the analysts said.

Earlier moves to roll high-rate assets into new, low-rated assets could limit some organizations’ ability to invest in the new, higher-rate bonds, the analysts said.

See also: