Falling interest rate – a potential threat to Life Insurers

Recently, a life insurance company announced losses due to creation of a 200 Crore reserve for guarantees (as per their press statement). This opens up discussion on falling interest rate and its impact on guarantees.

Falling interest rate is a threat

Falling interest rate is a potential threat to the life insurers. If interest rate falls below the level required to meet their guarantees, the guarantees given under various products will start biting the insurer.

We normally get carried away by what is happening today. If stock markets do very well, suddenly many people realize that they are losing the gains that some others are making. And hence buy stocks when the market is high. Thus, many people end up entering and exiting the market at a wrong time. Similarly, if interest rates stay high for sometime, we believe that they stay high forever.

What is the risk?

Many life insurance products, mostly traditional products, have got some guarantees in them. Not because life insurers got carried away by high interest rates. In fact, Insurers have kept some margin in interest rate assumption while committing to guarantees. But what if the interest rates fall beyond those margins? That’s the potential risk that the life insurers are running.

In non participating products, all the benefits are guaranteed upfront. Single premium products are not an issue, assuming the premiums are invested suitably for the guarantees. But regular premium products, where future premiums are yet to be received, are the problem. The future premiums may have to be invested in assets giving lower rate of interest (than originally committed to policyholder). And hence the products can fall short of the benefits guaranteed. A lot depends on the extent of fall in interest rates and the speed with which they fall.

Even in participating products, there are guarantees. Maturity sum assured is usually guaranteed. Bonuses once declared are guaranteed. Depending on the level and term of these benefits, they can create problems if interest rates fall below the desired level.

What is the solution?

If you come to a conclusion that interest rates have reached a level that can start creating problems to your company, you need to first stop committing to further guarantees. Re-price non participating products if you believe you can predict the rate of fall of interest rates for future. Else, stop selling non participating products. Start reducing bonus rates in the participating products. They may require re-pricing if the underlying guarantees (at point of sale) are still not sustainable.

What about the guarantees already committed? Reserve for them. The asset liability management has to be really robust to handle these guarantees and see if there are any opportunities to minimize the impact.

More importantly, don’t get into a guarantee war at any point of time. They killed many companies across the globe in the past and hence can kill many more companies in future as well.