CHICAGO–(BUSINESS WIRE)–US life insurers’ potential gain from further Fed rate hikes over the coming year could be muted if long-term rates remain largely unaffected, says Fitch Ratings. While yesterday’s Federal Funds target rate increase was expected, how further rate hikes effect credit fundamentals and the longer end of the yield curve is still to be determined.

If longer term rates decline to levels seen in late 2012 (i.e. 10-year Treasury below 1.75%) and stay low beyond 2016, Fitch expects the life insurance industry outlook to shift to negative. This ‘curve flattening’ scenario would weaken US life insurers’ earnings profiles and potentially weaken capitalization if insurers must boost reserves to meet future requirements.

The liability-driven investment strategies used by US life insurers require investment in long-term fixed maturity investments that provide a match to their long-duration liabilities.

A rise in short-term rates that leads to a corresponding rise in long-term rates (i.e. parallel shift in the yield curve, or further curve steepening) by 100 bps-150 bps over the coming year could have positive implications for our sector outlook provided US life insurers can effectively manage certain risk factors that may arise in such a scenario.

Positively, gradually rising interest rates across the yield curve provides significant benefits across all major life insurance and annuity products, favorably affecting reinvestment rates, interest margins and reserve adequacy.

However, a rising interest rate scenario could also increase risk associated with policyholder disintermediation, liquidity stresses related to collateral posting requirements on interest rate hedges, and uncertain statutory capital impacts associated with the interplay of variable annuity statutory reserves and related hedges.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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