Insurers selling their products in New Zealand aren’t feeling the pinch from the historically low global interest rates.
Experts say New Zealand life insurers are relatively insulted from market fluctuations.
A report released by Moody’s Investors Service, ‘Low Interest Rates are Credit Negative for Insurers Globally, but Risks Vary by Country’, explains how low rates around the world are causing the value of insurers’ investment returns to drop.
A co-author, Benjamin Serra, says, “We expect global interest rates to remain low by historical standards, so new money and maturing assets will be reinvested at yields that are lower than current portfolio yields. As a result, life insurers’ investment returns will continue to decline for many years.”
The report reviews 21 large life insurance markets and classifies them according to their vulnerability to low interest rate risk.
Moody’s says, “Insurers’ vulnerability to low interest rates is typically determined by their business mix, the level of guarantees offered, their ability to share the impact of declining interest rates with policyholders, and the gap between the duration of their assets and that of their liabilities”.
Germany, the Netherlands, Norway and Taiwan are among the countries most exposed to interest rate risk, while companies in Australia, Brazil, Ireland, Mexico and the UK are the least exposed.
The report notes that not all insurers in each country face the same level of risk, but there are similarities among companies operating in the same market.
New Zealand sitting pretty
While New Zealand isn’t included in the study, the managing director of Eriksens Global actuaries, investment strategists and business consultants, says low interest rates aren’t affecting insurers operating in New Zealand.
Jonathan Eriksen says New Zealand is “top of the pops” for the following reasons:
1. While interest rates are low by New Zealand’s standards, they’re high compared to the rest of the world.
Eriksen says the likes of the Netherlands have negative interest rates, where interest rates are below inflation.
This simply isn’t the case here.
2. The types of life insurance products sold here aren’t influenced by interest rates.
PwC insurance sector leader, David Lamb, explains overseas jurisdictions have savings components linked to their life insurance products.
While a portion of their premiums go towards life cover, a portion also goes towards endowments or investment policies, which they can get back at a certain age or event.
While these types of savings components has been particularly prevalent in the UK, Lamb says they're rare in New Zealand.
Rather, life insurance here is a term risk – you pay a premium and are entitled to a lump sum on death.
The insurer will pay you according to a contract, so from a customer’s perspective there isn’t much danger.
Eriksen adds the types of life insurance products sold in New Zealand are often annually renewable. He says people change their cover frequently – the average life policy collapsing after five years.
3. The Reserve Bank has tough solvency standards, which means insurers have to ensure they can protect themselves from the volatility of the market.
“Our regulatory regime caters for such shocks in terms of the amount of capital that insurers need to hold at all times in order to be solvent”, says Eriksen.
“Insurance companies have to hold assets to prove that they’re solvent, and that’s done on the basis of what sort of assets they hold.
“So if they have government stocks, they don’t have to have such a high asset margin. But if they’ve invested in things that are more risky – the odd share or something like that – they’ll need to hold extra capital to cover for any market shocks.”
Eriksen says life insurers’ assets are diversified more than general insurers’.
Furthermore, he says companies have created more capital to meet the Reserve Bank's solvency standards by increasing premiums.
Lamb adds many insurers operating here are Australian, so have to abide by the tough rules set out by the Australian Prudential Regulation Authority.
How insurers in other parts of the world are more vulnerable to low interest rates
The report says insurers’ vulnerability to low interest rates is typically determined by four factors:
1. The proportion of guaranteed products and other interest rate sensitive products in the business mix.
As mentioned above, insurers most vulnerable to a low interest rate environment are those with large portfolios of either insurance savings products that promise long-term guaranteed rates or other long-term products, such as long-term care products or annuities, which are priced assuming a certain level of long-term interest rates.
2. The level of guarantees offered.
Generally, the higher the guaranteed rate promised to policyholders, the higher the risk that an insurer’s investment returns will fall below the guaranteed rate.
3. The ability to share the impact of declining interest rates with policyholders.
As a general rule, the lower the spread between an insurer’s investment returns and the guaranteed rate, the higher the risk that the investment returns will fall below the guaranteed rate.
4. The gap between the duration of the insurer’s assets and the duration of its liabilities.
When the duration of a life insurer's assets is shorter than that of its liabilities (meaning that, on average, its assets will mature before its insurance obligations do), the insurer will have to reinvest a part of the portfolio before its policies mature.
If insurers promise a high guaranteed rate to policyholders and interest rates subsequently fall, they could be forced to reinvest at a yield that will prevent them from paying the guaranteed rate.
Moody’s says, “Insurers are acting to counter the risk of low interest rates, particularly by lowering credited rates on in-force policies and reducing guarantees on new business.
“They are also changing their business mix by diversifying into health, protection, unit-linked products or asset management, and modifying their asset allocation. Some of them are hedging interest rate risk through derivatives.”