The people who run the Federal Reserve System spend most of their days working with banks.
Fed system employees and visiting scholars collect data on the insurance industry. They publish sophisticated papers on the economics of insurance and long-term care finance. In spite of that, they tend to talk more about credit risk and the benefits of low rates for borrowers than about topics such as adverse selection, or the challenges low rates pose for insurers and retirement savers.
The staff of the Federal Reserve Bank of Atlanta took a step toward beefing up financial policymakers’ knowledge of the insurance industry earlier this month by including Scott Sleyster on the speaker list for its 22nd annual Financial Markets conference.
Sleyster is the chief investment officer for Prudential Financial Inc., one of the world’s biggest issuers of life insurance and annuity products. He’s been head of Prudential’s full-service retirement service and head of its guaranteed products business. He now helps the company oversee about $1.3 trillion in assets, and the reserves supporting $3.7 trillion in life insurance.
Sleyster helps decide what investments go into the general-account portfolios backing the annuities Prudential sells, and what investment options go onto the menus for annuity separate accounts.
Sleyster was the only Atlanta Fed conference speaker listed who now works for an insurance company, and, apparently, the only one who has worked for an insurer since 1998.
The conference organizers put him in a session on the effects of low interest rates.
Here’s a look at five things Sleyster told the conference attendees, based on a written version of his presentation.
1. Prudential tends to use high-quality fixed income assets to support its liabilities.
One sobering implication of Sleyster’s presentation is that, even though he was speaking at a conference aimed mainly at people with experience in economics and the financial services industry, he felt he had to explain that life insurers tend to make heavy use of high-quality fixed income investments. He did not think he could assume that this basic fact of life insurance company existence was something conference attendees would know.
2. Prudential can use derivatives to manage interest rate risk.
Sleyster noted that Prudential faces duration risk, or risk related to uncertainty about how long liabilities will actually last, as well as interest rate risk.
The company tries to manage both types of risk both by having risks from different types of products offset each other and by using investment assets that should last about as long as the liabilities.
Thanks to the use of derivatives and other investment-management techniques, in the short run, “the impact of low interest rates is consequently fairly modest,” Sleyster said.
3. Regulatory guidelines, rating agency guidelines and market forces restrict how aggressive insurance investment portfolios can get.
Central bankers might hope that low interest rates will prod ordinary individual investors to get their cash out of passbook savings accounts and invest it in innovative young companies that will help make the overall economy stronger.
Sleyster pointed out that insurers’ mix of assets has tended to remain relatively constant.
Insurers’ have kept below-investment-grade bond holdings at 5% of the portfolio over the past decade, and the share of assets invested in stock has actually shrunk, he said.
He pointed out that the share of assets invested in stock fell to 4% in 2016, from 8% in 2006.
Chillicothe, Missouri, in the early 1900s. (Photo: AP)
4. The current “low” returns on U.S. Treasuries might be normal.
Prudential was founded in 1875. Sleyster presented a chart showing what U.S. Treasury rates have looked like since the company was founded.
Typically, Treasury rates have varied from about 2% to about 4%, with occasional spikes up to 6%, according to Sleyster’s chart.
The chart suggests that the period from 1975 to 2005, when Treasury rates ranged from 6% to 14%, was the anomaly.
“Recent experience represents a return to the 2% [to] 4% range that persisted for nearly a century,” Sleyster said.
5. Low rates are not fun.
Sleyster’s presentation is notable for lack of drama. He did not imply, in any way, that low rates would cause the sky to fall on typical life and annuity issuers any time soon.
“However, there is a negative effect on surplus assets, optional or unexpected changes in cash flows (experience different than expected) and tail cash flows as they roll into the investable horizon,” Sleyster said.
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