How insurers can handle interest rate risk

Long-term interest rates remain historically low, and the U.S. Federal Reserve has no plans to raise rates until 2014.

That creates serious risks for life product guarantees, Bernie Wolf, economics professor, Schulich School of Business, York University told our Distributors’ Summit.

“Products like universal life policies depend on relatively high interest rates to keep the policy going,” he says. “It can end prematurely if interest rates are too low.”

Wolf’s not immune to the effects of flat rates. He bought a policy during a high-interest-rate period that was supposed to last until he reached his late 90s. That policy will now terminate when he’s in his mid-70s because the issuing company can’t sustain the payout.

“Insurance companies suffer financial hardships with low interest rates when they’ve given out guaranteed minimum payout rates during high-interest times, and when they haven’t locked in high rates on their own assets,” he says.

So companies must produce products that will minimize their risk as well as risk for clients.

“If clients are unwilling to accept annuities with low interest rates and payouts, [companies] have to come out with more flexible, enticing products.”

In April 2012, one company lowered its rate for a guaranteed product by 75 basis points—a considerable drop. But a definite payout makes the fees tied to the product more tolerable, he says.

Companies may eventually change actuarial standards based on longevity. At this point, however, they have to cut into margins.

“If the product isn’t moving, there are ways to repackage it, or you have to cut profits,” he says.

Wolf uses the example of airlines offering seat sales. Although insurers and MGAs can’t offer extensive discounts, they may have to lower prices by reducing fees or payouts.

Also, it’s necessary for advisors to make sure life products are transparent, explaining what products do and don’t do, so there are no nasty surprises for clients down the road.

Average U.S. treasury bond grade rate

Year(s)	Average Rate*
1960-1969	4.85
1970-1979	7.5
1980-1989	10.59
1990-1999	6.66
2000-2009	4.44
2010	3.22
2011	2.78
2012	1.47

*As of June 1, 2012

Source: U.S. Department of the Treasury

Suzanne Sharma is associate editor at Advisor Group.