The Federal Reserve’s increase in short-term interest rates should benefit life insurers and their policyholders, according to a new report.
Moody’s Investors Service arrives at this conclusion in a Dec. 14 “Sector Comment” report. The research examines the effect of the Federal Reserve’s rate hike on U.S. financial institutions, including banks, life insurers and asset managers.
On Dec. 14, the central bank’s Federal Open Market Committee, the Fed unit that determines monetary policy, increased its benchmark federal funds rate by 25 basis points, following a two-day meeting in Washington. According to a Bloomberg story published on Wednesday in LifeHealthPro, three more quarter-point rate increases are expected in 2017, up from the two previously forecasted in September.
“The rate hike should provide an immediate, modest boost to net interest income; and the economic strengthening that prompted the Fed’s action should also support borrowers’ creditworthiness,” the Moody’s report says. “For life insurers, the rate hike will help reverse the downward march in investment portfolio yields, as well as potentially lessen the need for further statutory and GAAP charges/write-downs, a key risk for life insurers in a prolonged low-rate scenario.”
The Fed’s quarter-point rate increase is the first since 2015. Last year’s rise ended a seven-year period during which the Fed maintained a zero to 0.25 percent target range for its benchmark rate.
Moody’s suggests the Fed may now shift to a “more normalized policy rate environment” that financial institutions need to achieve greater profitability. Among them: life insurers, whose balance sheets are “highly sensitive” to changes in interest rates because they invest heavily in interest rate-sensitive vehicles such as corporate bonds, which account for about 75 percent of the carriers’ investment portfolios.
As life insurers’ portfolio yields rise in tandem with further interest rate increases, the report observes, the companies will enjoy an easing of “spread compression” — the difference between the rates they generate on investments and crediting rates owed to policyholders — for the 60 percent of carrier liabilities tied to interest rate movements. These liabilities include “large blocks” of policies that generate minimum crediting rates.
Whatever gains life insurers generate from increases in short-term rates, the report cautions, yields on long-term investment vehicles will have a greater impact on their financial strength over time. Such long-term gains could positively affect interest crediting rates for holders of fixed annuities, universal life insurance and other interest-sensitive protection products.
“Should the rise in short-term rates translate into higher, sustainable long-term rates, the profitability of older annuity blocks — fixed and immediate annuities and structured settlements — should gradually begin to improve, along with currently depressed levels of sales (i.e., fixed annuities),” the report states. “Other long-tailed specialty products, like long-term care and long-term disability [insurance], will particularly benefit, as will interest-sensitive life insurance coverage, like universal life.”
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