The Fed rate debate: How insurers cope with interest rates

A clear and cohesive multiyear strategy for treatment of interest rates by the Federal Reserve is something the financial services industry would very much like to see.

Surprises and indecision are no good for planning and investing. Unfortunately, the disagreement between President Donald Trump and Federal Reserve Chairman Jerome Powell, in addition to just being awkward, created too much uncertainty in recent months.

The betting markets anticipated a resolution to that dispute that would result in the Fed slashing its federal funds rate during a meeting scheduled after this issue went to press. The funds rate is the interest rate at which U.S. banks and credit unions lend reserve balances to each other overnight.

As of early September, the Fed held rates steady at 4.25% to 4.50%, a rate unchanged since December 2024.

The federal rate influences borrowing costs across the economy and affects consumer spending, investment and inflation. And because the dollar is the dominant currency around the world, a rate change echoes globally.

Speaking in late August from Wyoming, Powell seemed to be coming around to the president’s point of view.

“The stability of the unemployment rate and other labor market measures allows us to proceed carefully as we consider changes to our policy stance,” Powell said. “Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.”

Widespread impact on insurance

Interest rates are inextricably tied to the world of insurance. Any rate changes have a powerful effect on insurers, on both how they make money and how they price products.

Insurance companies like to invest premium dollars in safe places, mostly in bonds and fixed income. Rising interest rates mean higher yields and stronger investment income over time.

Lower interest rates mean lower yields and a squeeze on profitability since insurers can’t earn as much on their large bond portfolios. A low-rate environment persisted for many years, forcing insurers to seek out private equity partnerships and asset managers who could deliver higher returns.

The shift forced many life insurers to hedge their risk with big reinsurance deals, some with offshore reinsurance companies. The interest rate impact on insurance company investments isn’t likely to reverse itself anytime soon.

However, any change in rates is felt quickly on the product side.

Many life and annuity products promise minimum guarantees. When market rates fall below those guarantees, insurers face spread compression. That is, they must pay more than they earn.

For annuity sellers, low rates hurt the appeal of traditional products like fixed annuities and whole life. The industry tends to innovate more with indexed products that can cap participation but still give consumers participation in the markets.

The insurers use any yield from bond investments to pay for both the carrier’s expenses and profit and to fund option purchases necessary to hedge index-linked interest credits on the indexed products.

“If bond yields are higher, the amount available to spend on options will increase, which allows for higher credited rates,” explained Ryan Brown, head of annuity sales and general counsel at M&O Marketing. “Similarly, if bond yields are lower, the amount available to spend on options will decrease, which will require lower credited rates.”

Insurers must react nimbly to any interest rate changes, noted Alan Assner, head of individual annuities at The Standard. But companies also track the 5- and 10-year Treasury rates as a benchmark of sorts, he said. The Standard will adjust its crediting rates if rates fall, Assner confirmed.

“It’s not necessarily one for one,” he added. “We look at the basket of assets that we would purchase to back these particular products. And if it’s a five-year product, and we’re looking at shorter duration corporate bonds or mortgages or things like that that we would use to back our portfolio, we would look at how they’re reacting and what they’re able to credit at that point in time.”

Rate changes also have an impact on policyholder behavior. Amid declining rates, policyholders are likely to hold onto older, high-crediting policies. This creates a higher liability for insurers.

Likewise, surrender activity may decrease, as policyholders don’t want to give up a good guaranteed rate.

Overall economic climate

Interest rates have an undeniable impact on clients, their portfolios and any indexed products they might own. But the underlying financial data driving rate-cut decisions is really the forest rather than just the trees.

Employment, inflation and wage data are all on tenuous ground as employers and wholesalers struggle to offset the cost of tariffs imposed by the Trump administration.

The odds of a recession for the U.S. economy are hovering around a nearly 50-50 chance, with forecasts from organizations like Moody’s Analytics placing the probability of a downturn in the next 12 months around 49%.

Meanwhile, analysts strongly favor a second rate cut in December.

InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at john.hilton@innfeedback.com. Follow him on Twitter @INNJohnH.