Rate Rise Signals a Merry Christmas (Finally) for Life Carriers

Dear Life Insurance Carriers: Merry Christmas. Signed, Janet Yellen, chair, Federal Reserve Board.

With the U.S. central bank raising its benchmark interest rate (by 0.25 point) for the first time in nearly a decade, the question is who benefits?

Life insurance executives, for one.

“Life insurance company executives are definitely cheering the Fed on. I can hear them yelling, ‘Yellen, Yellen, Yellen,’” said Dr. Robert R. Johnson, president and CEO of the American College of Financial Services in Bryn Mawr, Pa., in an interview with InsuranceNewsNet.

For life insurance managers, Dec. 16, 2015, couldn’t have come soon enough. Some were beginning to even wonder if a rate rise would ever come.

The Federal Reserve raises its benchmark lending rate to make sure the economy doesn’t grow too fast, and the central bank lowers rates to make it less expensive to borrow in hopes of stimulating economic activity.

For life insurance carriers, rising rates ease spread compression.

Spreads compress, or tighten, when carriers, paying out liabilities to life insurance policyholders and annuitants at a fixed rate, find that they can only re-invest premiums at even lower rates because interest rates have declined.

Carriers find they can’t make enough on their invested assets to deliver on their contractual liabilities — a phenomenon that has dogged life carriers since rates began their long decline.

As rates rise, insurance carriers will be able to invest premiums and roll over maturing bonds into higher-yielding investments. About 74 percent of the life insurance industry’s invested assets are in bonds.

“Bond yields are going to rise in response to higher rates,” said Johnson, author of “Invest with the Fed.”

“This initial 25 basis point change isn’t really going to have impact on economy,” he added. “But what it does is it signals a future course of action to the Fed. The last thing the Fed wants to do is raise rates and reverse course in near term.”

With the Fed having been so cautious before raising rates for so long, some analysts say it augurs well for more than one rate increase in 2016.

Market watchers are already talking about how fast rates should rise next year.

Anthony Valeri, an investment strategist at LPL Financial, told Financial Planning earlier this week that the questions circulating among industry analyst and market experts revolve around the pace of future hikes.

“What’s more important is the pace of the rate hikes: how many do they do, over what time frame, and what’s the magnitude form how quickly they raise rates from the first hike to the last,” Valeri said in an interview with Financial Planning.

A slowly increasing rate environment is the ideal scenario for the life insurance industry as management re-invests assets in bonds with progressively higher yields.

Gradually rate increases allow carriers to adjust their credited interest and more appropriately match their assets with the liabilities, according to actuary Larry Bruning and researchers Shanique Hall and Dimitris Karapiperis.

Their research was published earlier this year by the Center for Insurance Policy and Research, the research arm of the National Association of Insurance Commissioners.

Moody’s Investors Service Inc. said it expects the federal funds rate to increase by 150-200 basis points over the next two years, half the pace of increases during the last tightening cycles in the mid-2000s.

“Life insurers will benefit from a gradual improvement of investment returns, particularly those companies that have written significant policies that provide guaranteed rates to policyholders,” a team of Moody’s credit analysts wrote Tuesday in a research note to clients.

New life insurance and annuity contract holders will also fare better than buyers who bought a year ago because the contract will pay more, Johnson said.

Millions of people in the market want annuities to generate guaranteed income, but some advisors have found it hard to pull the trigger on an annuity purchase because terms haven’t been that attractive and carriers have been gradually ratcheting back on benefits.

“The deals out there for annuities are not very good so for potential policyholders and annuitants, rising rates are good news,” Johnson said.

The past two years, the Fed has flummoxed analysts. At this time last year, many market watchers were expecting the Fed to raise rates. It didn’t. In the winter of 2014, analyst chatter about rising rates was similarly squelched by the central bank.

But unemployment was higher then. November’s unemployment report pegged the figure at 5 percent, down from 5.8 percent last November and 7.2 percent in November 2013, according to the Labor Department.

Unemployment is half what it was — 10 percent — in October 2009, five months after the nation had officially emerged from recession.

Among the only buyers inconvenienced by the rising rate environment are life insurance policyholders and annuitants who bought in the past five or six years: their policies became more valuable as interest rates fell and gradually paid out less and less.

But with rates no longer falling, the game has changed.

Still, for the rest of the industry, the rate game has changed for the better. “Janet Yellen put something in the stockings of the life insurance companies,” said Johnson.

InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

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