Members of the long-term care (LTC) planning community celebrated last week when interest rates started to creep up out of the bowels of the Earth.
The Federal Open Market Committee (FOMC) said it was increasing the federal funds rate 0.25 percentage points, to 0.5 percent.
The Federal Reserve Board increased the federal discount rate 0.25 percentage points, to 1 percent.
Many agents, brokers and others tried to make a good show of acting as if they understood what that meant.
The American Association for Long-Term Care Insurance (AALTCI) put out a statement welcoming the rate news.
“Consumers want affordable options they can feel about, and rising interest rates will benefit both prices and the sense of financial stability,” Jesse Slome, AALTCI’s executive director, said in a statement.
So, why are Slome and other members of the LTCI community smiling about the rate increase?
For an explanation, read on.
1. What exactly are the FOMC’s federal funds rate and the Federal Reserve system’s discount rate?
The Federal Reserve system is a collection of giant government-chartered banks that manage the U.S. monetary system. The federal funds rate is the rate those giant banks charge each other for loans.
The federal discount rate is the rate the Fed charges commercial banks when they borrow money from the Fed. But commercial banks aren’t normally supposed to borrow money from the Fed.
2. Why do issuers of long-term care insurance (LTCI) care so much about interest rates?
Issuers of LTCI, long-term disability (LTD) insurance and other products with potentially long benefits durations, or benefits triggers that could occur far in the future get some of the money they pay out by investing premium revenue in high-grade corporate bonds and other classes of assets that state insurance regulators view as being safe.
Issuers of products with long-term obligations also use interest rates when deciding how big of a reserve they have to set aside to support the claims they’ve already decided to pay.
For issuers of LTCI and LTD products, managing portfolios in the low-rate environment of the past decade has been like trying to grow corn during a severe drought.
The impact has been even harder on issuers of LTCI, and individual disability insurance, because issuers of those products typically have less ability to change premiums than issuers of group LTD products do.
3. Why don’t LTCI issuers just invest in something that pays higher rates?
They try, but state insurance investment guidelines, which are based on standards developed by the National Association of Insurance Commissioners (NAIC), discourage the issuers from putting a big share their assets in stocks and other instruments viewed as being less dependable than high-grade bonds.
4. Why are corporate bond rates so important to insurers?