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Swiss Re sigma study explores how interest rates affect insurers.

Swiss Re's latest sigma 4/2012, Facing the interest rate challenge, explores how interest rates affect insurers and explains why a rapid rise in or sustained low interest rates can be a challenge.

Life insurers are more impacted than non-life insurers, but even within life insurance, interest rate sensitivity varies by product, with savings business being the most affected. Consequently, life insurers must re-price their guarantees and also adjust their product offerings to mitigate their exposure to interest rate risk. Non-life insurers need to raise premium rates to compensate for low investment yields.

Interest rates have been trending downwards for the last 30 years, with yields on 10-year government bonds falling well below two per cent recently in many markets. While the current low interest rates help over-indebted borrowers deleverage their balance sheets, not everyone benefits from them. Insurers, as large institutional investors managing around $25 trillion or 12 per cent of global financial assets, suffer greatly from low investment yields. The impact of low interest rates on insurers also affects policyholders because the cake shrinks for all - translating to fewer benefits or to higher premiums for equal protection.

Low interest rates affect insurers slowly because only current premium income − a fraction of total investments − is invested at market yields. Astrid Frey, co-author of the sigma study said, "Interest rates have a delayed impact on insurance investment portfolios, allowing insurers time to react but also tempting them to postpone necessary remedial action in hopes that interest rates will rebound." Insurers can usually cope well with stable and mean-reverting interest rates, but sudden swings from one regime to another are a challenge to the industry.

Not all lines of business are impacted equally

Although interest rates affect all insurers, some lines of business are much more vulnerable than others. Interest rates have the largest impact on long-term business where investment income is a major source of earnings. In non-life insurance, however, the interest rate risk in long-tail business (such as casualty) can be contained through prudent asset-liability management. On the life insurance side, savings products are the most exposed to interest rate risk because investment income is the main source of profit. In addition, hard-to-predict policyholder behaviour, such as lapses, makes it difficult for insurers to project their cash flows, thus complicating their asset-liability management.

"Even within the life insurance savings business, interest ra

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Publication:CPI Financial
Date:Sep 22, 2012
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