Insurers need to plan reactions to rising interest rates: E&Y

The movement by the U.S. Federal Reserve to gradually increase interest rates means that insurers must plan now how they will react to this trend, says Ernst & Young LLP in its fourth quarter outlook on the insurance industry.
E&Y’s “insurance and actuarial advisory services” (IAAS) practice says, despite the traditional view that rising interest rates are a negative force for insurers given their heavy investment in bonds, the persistent low rates experienced over the past several quarters has actually been a concern for the industry. Low rates have put pressure on realized spreads and thus had a negative impact on bottom-line earnings, the analysts say.
The measured pace of current interest rate hikes (which is expected to continue through the end of 2005) is welcome news for insurers, but a “quick spike” in rates could create what E&Y describes as a “domino effect” on the life insurance side of the business. Consumers may be tempted to cash in policies for higher yielding alternatives, which could force insurers to subsidize credit rates to compete or liquidate assets to fund departures.
“The way in which companies position their assets and liabilities prior to rate hikes, and the nature of their approach to hedging and active management strategies, will dictate the financial effects they experience as rates begin to rise,” says Mike Hughes, a senior actuarial advisor with IAAS.
On the property & casualty side, the biggest concern is the softening of premium rates, and E&Y cautions against insurers falling into the competition trap.
“Soft markets are not a naturally occurring phenomenon. They are the results of management actions,” notes Chris McShea, national director of p&c for IAAS. “The growth through volume game is lose/lose, as each price reduction increases the number of new units needed to grow premium. History has shown that this slope grows more slippery with each and every price cut.”
McShea advises insurers to avoid seeking volume and instead focus on repairing relationships with distribution channels and consumers, alienated by the recent hard market. Customer service and enhanced technology are two means of achieving this, he points out.