How the Fed’s Rate Hike Affects the Insurance Industry
December 28, 2015 by John Weber: John.Weber@ambest.com
OLDWICK, N.J. – A panel of economic, insurance and investment professionals examine the latest rate increase and how it will affect various sectors of insurance.
View the video version of this interview at: http://www.ambest.com/v.asp?v=interestrate1215
Following is an edited transcript of the interview.
Q: This past Wednesday the Federal Reserve announced it would be hiking the interest rate by a quarter percent. What will this mean for insurers? We’ve got a panel of experts who will be discussing this today. They are Howard Mills from Deloitte, he’s the global insurance regulatory leader. Also joining us are Rich Sega, CIO of Conning. Stewart Foley is a partner with Insurance AUM and Meg Mulry, senior economist with A.M. Best. Meg, let’s start with you. What will this rate hike mean for insurers?
MULRY: Right now the rate hike will have a very minimal effect on the day to day operations for insurers. Longer term is what we’re looking at, the pace at which the Federal Reserve tightens their monetary policy. They’ve described it as going to be a gradual pace. Even now we can see sort of a disconnect in the market expectations versus the expectations for what the Federal Reserve has currently set out as the pace at which they will be raising rates going forward.
We’ll be watching that very closely. In the near term, I think it will be a very small impact. Obviously it was very well telegraphed to the market, that they were going to be making these changes. We saw very little disturbance. That’s what we were expecting, that calm to carry forward until maybe March when we see another rate hike from them.
Q: Will this rate increase impact any one segment of the industry more than another?
MILLS: Well, certainly its of interest to the entire industry. All insurance companies rely on investment earnings to help the bottom line. But it’s most acutely felt in the life side of course. The life insurance industry has so many long-tail products. So much of their bottom line is based upon their very significant investments and investment earnings. They were really hoping probably to see a more substantial interest rate hike. They’ve been dealing with a low interest rate environment for so long and it has impacted their bottom line quite severely.
Q: How will insurers be tweaking their portfolios based on this rate hike?
SEGA: I’ve been thinking about this as watching a low-budget horror movie, where the young lab assistant is standing by the bench and over her shoulder you can see the body on the slab covered with a sheet. You’re waiting for it to move and it just doesn’t move for the longest time. When it finally does everybody screams and it drives them crazy. But it’s very cathartic. It takes all the suspense out of it. You can finally see the monster. You know what it looks like and the hero can figure out how to defeat it. The whole character of the movie changes.
That’s what we thought was going to happen when this first move occurred. But as Meg suggests, and we agree, it’s a very minimal effect from a practical standpoint because except for the very shortest lines of business this won’t really help the compressed margins that insurance companies feel. So the strategies that we’ve been trying to employ, diversifying asset classes and in particular looking at less-liquid asset classes, private placements, maybe equity with income characteristics, that’s the same kind of efforts that investors for insurance companies will continue to make because we continue to need income.
The one tweak we might see is looking for more interest-sensitive stuff like CLOs and floating rate products, leveraged loans, that might participate in any continued follow-through of rising rates from this. But generally we are in the same position that we’ve been in for a long time. It’s going to take some years to age out of it I think.
Q: We’ll be looking at similar rate hikes throughout the year. What will that mean as we move forward?
FOLEY: It depends on how many more rate increases there. The Fed has telegraphed or said that they’re going to do a total of four, at least that’s the market’s expectation but it remains to be seen how many they actually do. When you look at inflation, which they are targeting the price level as energy prices come down, there is downward pressure on the overall level of inflation.
There is no guarantee that the Fed will continue to raise rates. If they do it’s likely to have much of impact on the back end of the yield curve where most insurance companies invest. Because as the Fed is raising the short rate it puts downward pressure on inflation expectation, which will put downward pressure on the long end of the yield curve, causing the yield curve to flatten. So out in the area where most insurance companies are investing you’re unlikely to see a significant increase in those interests.
Q:. So what would insurers like from the Fed?
FOLEY: The overarching, what’s good for the insurance industry is consistent with what’s good for the U.S. economy. Clearly managing the sustainable growth rate and managing the economic well being of the U.S. economy is good for the insurance industry. But how the Fed perceives inflation, particularly in the face of falling energy prices, remains to be seen.
SEGA: I think that’s exactly right. We of course need higher yields for the operations for our clients but what we really need is economic growth. We’d like to see the Fed do things that would help that. One of the first things I think they should is go back from being date dependent, to change that E back to an A and be really data dependent and react to real data in the marketplace and not some engineered employment numbers that really aren’t telling the true story.
FOLEY: I would echo that, what Rich just said in terms of the data that’s being used. That’s a very good point.
Q: We remind viewers that A.M. Best does have a paper out on the topic. It’s called, “Insurers Hope Fed Move a Sign of Things to Come.” You’ll find it online at www.ambest.com.
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