After the Great Recession of 2008 – 2009 the federal funds rate hovered between .07% to 1.68% for thirteen years! Insurers adopted riskier investment strategies in an attempt to boost their yields. Pursuing greater yield through alternative investments in private equity or FHLBs left aggressive insurers more exposed to the market volatility that has accompanied rising interest rates. This search for yield will be less challenging as interest rates rise. What are the other impacts of high interest rates on insurance companies?
Risk Management and Regulatory Compliance
Assessing their exposure to interest rate risk is a significant part of any insurers overall risk management strategy. Higher rates mean more options available for investment. Fixed-income securities like bonds with longer maturities can serve to lock in higher interest rates. All investment diversification must fall within the minimum solvency and capital adequacy standards set by regulators. Meeting these standards and maximizing return is a balancing act for the impact of high interest rates on insurance companies.
Insurance companies have long-term liabilities as they pay out claims to policyholders over extended periods. Matching these long-term obligations with similar duration assets helps them avoid exposure to interest rate risk. While P&C insurers also benefit from increased bond portfolio yields, higher-than-expected claim costs for home and automobile lines may impair earnings.
Policy premiums are often fixed for a specified period, such as a year. When interest rates rise, insurance companies may reprice policies to reflect the increased investment income they can earn on premium payments. This helps offset the impact of higher interest rates on their profitability.
After so many years of very low interest rates insurance companies will need to increase their policyholder communication to explain changes and calm concerns about increased costs. The same impact of high interest rates on insurance companies can also be happening to insurer’s clients.
Balancing the pursuit of higher returns with the need to maintain financial stability and fulfill their obligations to policyholders drives every insurance company’s business strategy. Shifting gears after thirteen years of very low rates is critical to each company’s profitability and future growth.