Lower-for-longer interest rates will continue to challenge life insurers

The dramatic decline of the 10-year US Treasury yield to historic lows in 2020 raised concerns in the life insurance industry about the increased likelihood of lower-for-longer interest rates, said  S&P Global Ratings in the report ‘How Prolonged Low Interest Rates Could Affect U.S. Life Insurers.’

"While inflationary risks have risen because of increases in consumer prices--prompting the question of whether the Fed will raise interest rates--in our base case, we expect a lower-for-longer interest rate environment," said S&P Global Ratings credit analyst Anika Getubig. S&P Global economists' base-case scenario calls for an average yield on 10-year US Treasury notes of 1.7 percent in 2021 and 2.2 percent in 2022.

Prolonged spread compression necessitates that life insurers balance product offerings, growth, profitability, and customer value. But while this pressures operating performance, ratings currently remain stable due to a supportive regulatory environment, diversified business profiles, sound risk management practices, and strong capital buffers.

"Put simply, rates matter because rates ultimately influence a life insurer's investment returns and earnings, the calculation of the liabilities or reserves, and pricing," said Getubig.

If over time established reserves need to be reevaluated because of lower interest rates, reserves increase and that reduces earnings. If reserve increases are sizable enough that they result in a net operating loss, this could erode capital.

The impact of low rates will vary by issuer, product suite, capital position, and overall net earnings spread. Companies that hold annuities with guarantees would be the most sensitive. Nevertheless, S&P Global Ratings expects life insurance companies will be able to withstand such headwinds in the coming few years.

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