The Impact of Rising Interest Rates on Life Insurance and Annuities

One of the big downsides of incredibly low short-term and long-term interest rates was that fiduciaries such as life insurers and pension managers were starting to have a very hard time making enough nominal returns over the long haul to be able to match up their future commitments. It turns out that Ben Bernanke and the Federal Reserve’s low interest rates have been competing with (and hurting) life insurance and annuity markets. Now we have a report out from Moody’s suggesting that a continued rise in interest rates would be credit positive for the U.S. life insurance sector, but a rapid rise in interest rates might prove to be very bad for the same insurers.

The gradual rise in rates would allow the insurance sector’s “spread products” to regain popularity and reinvestment risk would decline. The flip side is that a rapid spike in interest rates could push annuity policyholders to jump over into higher-return products right at the same time that the life insurance companies start to report unrealized losses in their investment portfolios, which are supposed to match off the long-term policies.

Moody’s even went as far as to say that the life insurance sector could be revised higher, to Stable from its current negative stance, if the recent rising interest rate trend and improving economy continues.

Moody’s believes that fixed-rate annuities and similar products would do well with gradually rising interest rates. It points out how annuities had been an industry growth engine for about 20 years before the incredibly low interest rates played into the equation. Other products that would benefit from a rise in interest rates would be structured settlements, pension products, universal and interest-sensitive life, long-term care and long-term disability products.

Again, the caveat about rising interest rates here is that it is based on there not being a rapid and steep increase in rates. A steep rise would be negative for most life insurers. The end result for now: “Moody’s believes the liquidity profile of most life insurers is strong, mitigating the impact of having to crystallize losses on assets to fund policyholder surrenders.”

As a reminder, the Treasury yields on the 10-year notes and the 30-year bonds rose about 100 basis points in just over 60 days from the start of May before settling back down in recent days.

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