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Interest Rate Limbo: Strategies for Managing Falling Interest Rates

Interest Rate Limbo: Strategies for Managing Falling Interest Rates. 2011 Annual Conference. Timothy C. Pfeifer, FSA, MAAA Pfeifer Advisory LLC. October 23, 2011. Over the Past Few Years, Significant Interest Rate Compression has Occurred. Is this really true?.

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Interest Rate Limbo: Strategies for Managing Falling Interest Rates

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  1. Interest Rate Limbo:Strategies for Managing Falling Interest Rates 2011 Annual Conference Timothy C. Pfeifer, FSA, MAAA Pfeifer Advisory LLC October 23, 2011

  2. Over the Past Few Years, Significant Interest Rate Compression has Occurred Is this really true? When was the last time 1OYT rates were this low?

  3. Over the Past Few Years, Significant Interest Rate Compression has Occurred What about the long end of the curve?

  4. Over the Past Few Years, Significant Interest Rate Compression has Occurred How does the steepness of the Treasury Yield Curve compare?

  5. Over the Past Few Years, Significant Interest Rate Compression has Occurred Insurers take on risk spread though. What has happened to credit spreads over the past 18 months?

  6. What Insurance Products are most Impacted by the Low Interest Rate Environment? High Declared Rate Fixed Annuities Fixed Index Annuities Immediate Annuities Fixed Universal Life Indexed UL Par WL Variable Product Term Life Low

  7. How have Insurance Carriers Responded to the Low Interest Rate Environment? Lowered current credited rates Lowered guaranteed credited rates Managed to higher spreads on in force business Increased explicit charges to permit higher credited rates Developed indexed products, especially those with GLWBs Exited lines of business Reduced investment asset quality Lengthened maturity on asset portfolios Developed more market value adjusted products Lower commissions

  8. How have Customers Responded to the Low Interest Rate Environment? Lowered expectations Explored indexed products Fewer lapses/better persistency on older business Examined alternative investments On Life side, look for other features, like LTC combos Postpone life insurance and annuity purchases, other investments Extend retirement timeline even more

  9. Asset returns drive product competitiveness either to a great degree or a moderate degree. What alternatives are there to improve asset yields in today's environment? Take credit risk Regulatory capital punishes Take duration risk Softer regulatory capital treatment Explore less traditional assets Investment partnerships, venture capital Use separate accounts Regulatory concern emerging

  10. Duration mismatching and taking credit risk are two very different sides of the coin - - - - - - - None - - - - - - Source: Bloomberg Composite as of September 30, 2011

  11. Credit Risk or Duration/Cash Flow Mismatch • Insurers feel that they understand and are good at taking credit risk, better than rating agencies, in fact. • Capital formulas punish credit risk on a security-by-security basis • Duration risk on assets is more efficient from a capital perspective, especially if carrier has a large diverse portfolio of business. • Implication – Go longer!

  12. Additional insurer responses to low interest rate environment over next 12–18 months • Fixed Annuities • Eliminate return of principal guarantees • Add more powerful MVAs • Add more GLWBs • Portfolio rate crediting • Indexed Annuities • Continue focus on income sale • Sweetened death benefits • More use of participation rate • Simple binary design

  13. Additional insurer responses to low interest rate environment over next 12–18 months • Life Insurance • Increased focus on indexed products with attractive caps supported by mortality/expense margins • More interest in products with ancillary benefits like LTC • Minimum credited rates dropped to zero • Larger surrender (and higher) for certain types of products

  14. Low cost of capital could result in life insurance carriers’ strategies including the following: Pricing with leverage Strong interest in purchasing mature blocks Significantly lower profit hurdles = risk-free plus a margin (500 bps) Production capacities increased

  15. Long-term lessons learned from recent interest rate environment • Carriers • Reconsider offering periodic, flexible premium annuities. • Manage asset-based businesses in aggregate. • Actively push for regulatory changes in market value adjusted life and lower minimum annuity credited rates. • Refine interest rate hedging practices. • Market consistent outlook? • Customers • Shop for products which show upside when interest rates fall (interest rate floors, bond funds). • Diversification is still as prudent as ever. • Despite underestimating when interest rates are low, tax deferral is still quite valuable. • Be smart – look for clues as to rising or falling rates (unemployment).

  16. Thank You! Timothy C. Pfeifer, FSA, MAAA E-mail: tpfeifer@pfeiferadvisory.com www.pfeiferadvisory.com

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