The mirage of high returns

One of the many reasons for the current hard market is that low interest rates have stunted insurers’ investment income, which commonly makes up for deficiencies in premium pricing. Absent significant investment returns, insurance companies must resort to ‘Plan B,’ which is to charge consumers higher premiums. That’s exactly what’s happening now.

But if insurers are waiting for interest rates to rise to help supplement their premium income, the news from financial observers is grim. They could be waiting for up to 20 years, according to one Swiss Re analyst.

“Interest rate levels are likely to remain extremely subdued for a long, long, long time,” predicts Jerome Jean Haegeli, group chief economist and managing director of Swiss Re.

Haegeli talked to Canadian Underwriter at the 2019 National Insurance Conference of Canada (NICC). “If you look at our latest forecast from Swiss Re, the 10-year forecast is 1.6% for end of this year, and at the end of next year about 2%,” he said. “Lower interest rates in the long run bears the question: What does the insurance company do? We looked at the case of Japan. On the one hand, for P&C it means more underwriting discipline, which could be a good thing. But there is only so much you can do.”

Haegeli looks to the zero-interest-rate policy of Japan, where for the past 20 years interest rates have been as low as you can go – 0%. In that environment, Haegeli observes, Japanese insurers are starting to look to make money in illiquid assets (real estate, stocks with low trading volume, or collectibles). Although illiquid assets still have (sometimes high) value, they are difficult to sell.

“We have to be realistic enough that some of the forces that drove the Japan rates to below [average statistical norms] are also playing out in the global economy,” said Haegeli. “That keeps rates lower for longer. I wouldn’t be surprised to see in 20 years’ time that we are going to have 40 years of Bank of Japan zero-rate policy. That backdrop is not favourable for interest rate increases.”

In Canada, interest rates “are not going to go up dramatically,” says David Chilton, a former Dragon on CBC’s Dragon’s Den and the best-selling author of The Wealthy Barber, a guide to financial planning. “Things are not going to normalize for a very long time, for a simple reason: There’s way too much debt in the world to allow for that.”

Banks lower interest rates to encourage people to borrow money; it is assumed that people will spend the borrowed money to get the economy moving again. Low interest rates have been in place since at least the global financial crisis of 2008. But the result of governments, companies and people borrowing money, as Chilton observes, has been massive debts on the balance sheets.

The U.S. debt reached $22 trillion as of Februray, according to the U.S. Department of the Treasury. Canada’s debt level, in contrast, sits at about $686 billion as of March 2019. But Canadians’ individual debt level is very high at 175% of disposable income.

Given these debt levels, to raise interest rates significantly now would risk triggering an immediate economic recession, Chilton told the 2019 Insurance Brokers Association of Ontario (IBAO) Conference.