Supply chain and labor market disruptions brought on by the pandemic have contributed to rising prices and higher worker salaries. The conflict in Ukraine is impacting energy cost and availability adding to the volatility in capital markets. As the Federal Reserve increases the cost of borrowing money what has been rising interest rates impact on the insurance industry?
This is the most beneficial area of rising interest rates impact on the insurance industry. Higher interest rates mean the search for yield for a company’s investments will be less challenging than it was when rates were near zero. It will be an opportunity to rebalance portfolios and move back into more traditional investments and rely less on alternative asset classes. Rising interest rates also allow insurers to invest new cash flows and maturing investments into higher rate instruments. Increases in investment yields from higher interest rates help offset any downward pressure on stock valuations as well.
For life and retirement providers, higher interest rates will broadly reduce reinvestment risk and make rate guarantees less expensive from an economic standpoint. Equity indexed life insurance and annuities will be less attractive to policyholders due to the volatility in the equity markets, but as rates rise insurers will be able to offer products with more substantive interest rate guarantees. P&C carriers may find coverage inadequate to keep policyholders whole after a loss in an inflationary environment. An unhappy policyholder is always a competitive problem. Making sure product structure and features are in line with an inflationary environment, even going beyond legally required minimums, may be critical to retaining customers.
Insurance companies generally benefit from rising rates and might be in a position to increase risk premiums for standard products. Because the insurance industry balance sheets and capital positions are very robust, it would take several years of higher inflation to negatively impact earnings. So, far no one is predicting an extended inflationary or recession environment. Increased profitability in the short term offers an opportunity to increase product competitiveness balanced against retained earnings.
Reinsurance and M&A
Low interest rated drove reinsurance and M&A activity over the past decade. Increase interest rates may lower the appetite for acquisitions or any purchase or sale transactions. A lower need to reinsure or transfer interest rate risks to other parties will also decrease activity in this area.