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Will FIO report help disability and LTC insurers?

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Low interest rates might be good for home buyers and growing companies, but they’re hard on life insurers that have written long-term disability (LTD) insurance, long-term care insurance (LTCI) and other products with long time horizons.

Officials at the Federal Insurance Office (FIO) — an arm of the U.S. Treasury Department created by the Dodd-Frank Wall Street Reform and Consumer Protection Act — have talked about the damage that low rates can do to life insurers in a section on major “currrent issues and emerging trends” at the end of the FIO’s new insurance industry annual report.

The FIO is supposed to prepare the report to help the Treasury secretary and other policymakers understand all aspects of the insurance industry, and especially any issues or regulatory gaps that could “contribute to a systemic crisis in the insurance industry or the U.S. financial system.”

The FIO officials who created the report put the section on the “impact of low interest rates” ahead of “natural catastrophes” and “changing demographics in the United States.”

The drafters of the Dodd-Frank Act specifically excluded the health insurance and LTCI markets from FIO oversight, but the officials who wrote the new report mentioned that U.S. life and health insurers did get about 27 percent of their $645 billion in total 2012 premium revenue by selling disability insurance, LTCI products, and other accident and health products.

FIO officials also pointed out that insurers are selling products through more distribution channels than they used to use. “Workplace selling” operations, for example, now sell health and other voluntary benefits, such as disability insurance, through payroll deduction programs, officials reported.

One trend has been efforts by the Federal Reserve System to help home buyers, home builders and growing companies with good credit ratings by keeping interest rates low.

Insurers have argued that the low rates have been hard on LTD and LTCI operations along with annuity operations and some types of life insurance policies.

The Federal Reserve Board has said little about the possible effects of low rates on insurers. 

The Dodd-Frank Act created a Federal Reserve Board financial think tank, the Financial Stability Oversight Council (FSOC), at the same time that it created the FIO. The FSOC is supposed to track trends that could threaten the stability of the U.S. financial system. But, in July 2011, when the FSOC issued its first report, it said nothing about the possible effects of low interest rates on insurers.

In the new FIO report, officials do not talk directly about the effects of low rates on disability and LTCI operations.

But, in a summary of the section on the effects of the current low interest rate environment, FIO officials said low rates have increased the present values of insurers’ contract obligations.

“While insurers would benefit from an increase in interest rates through improved investment returns, a sudden, significant rate increase could present threats,” officials said. “A sudden increase in general interest rate levels would increase unrealized losses in insurer fixed income portfolios and, at the same time, could prompt policyholders to surrender contracts for higher yield elsewhere. In such a circumstance, insurers could be forced to liquidate fixed income investments at a loss in order to fund [annuity] contract surrender payments.”

At the end of the FIO report, in the full version of the “current issues and emerging trends” section, officials said the effects of a sustained low interest rate environment could do more harm to life and health insurers than to property-casualty insurers.

“The extent of those consequences depends on a number of factors, such as the length and depth of the low interest rate environment, the composition and terms of the product offerings of an insurer, the extent to which an insurer has matched durations of assets and liabilities, and the degree to which it may have hedged risk through derivatives,” officials said.

If rates stay low, “life insurers may be tempted to ‘reach for yield’ by investing in higher-yielding, but riskier, assets,” officials said. “The risks of investment practices leading to higher yield and risk can be mitigated in part by state investment limitations and insurer risk management programs, but a certain level of discretion is allowed by both. Thus, a sustained low interest rate environment may lead insurers to offer products for which risk management becomes more tenuous.”

Life insurers could try to manage rate risk by hedging, but using hedging programs could expose insurers to the risk of the other parties involved in the hedging arrangements collapsing, officials said.

The cost of a hedging program could outweigh the financial benefits, officials added. 

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