Interest rate rises are anticipated by S&P
Although a rise in interest rates is likely over the next two years, this will not be enough to prevent life insurers having to implement more fundamental strategic shifts if they are to restore earnings to historical levels.
That was the view of Standard & Poor's (S&P) in a recent report called ‘The Low-Interest-Rate Fog Over Global Life Insurers May Be Lifting.’ In it, the rating agency said an anticipated rise in long-term interest rates could help improve the financial strength of global life insurance companies but would not be enough to revive them completely. It also added that Japanese and German life insurers were particularly vulnerable to interest rate movements.
“We anticipate that long-term interest rates – a key factor influencing the sector's financial strength globally – will edge upward in 2014 and 2015, provided that the global economy continues to gain a firmer footing and in the absence of financial sector stress," said Standard & Poor's credit analyst Karin Clemens.
“Still, we believe an upward move in interest rates won't necessarily be sufficient to revive the fortunes of life insurers whose business models depend heavily on interest-rate-sensitive product lines, such as traditional long-term savings products with fixed guarantees.
“While a rise in interest rates could modestly lift life insurers' economic earnings and capital, we think it likely that some companies will still have to make a further strategic shift to fully restore earnings' momentum.”
Such adjustments to business models may range from nuanced to bolder changes, depending on the company and the market in which companies operate, S&P said. Our assessment of individual life insurers' credit quality will depend partly on local market conditions, but also on the strategic direction management takes in response to the ongoing interest rate challenge.
S&P considers German and Japanese life insurers to be typically highly sensitive to interest rate movements, not least because of the heavy presence of contractual guarantees within their books. US life insurers, meanwhile, have only mid-level sensitivity and UK life insurers have only low-level sensitivity to low interest rates because products with investment guarantees play a lesser role.
The report concludes that an effective and sophisticated regulatory framework can also help protect life insurers' credit quality by incentivising effective risk management.
