Impact of Prolonged Low Interest Environment on Life Insurance

Transcription

1 Impact of Prolonged Low Interest Environment on Life Insurance 2003 SEAC Fall Meeting Michael S. Taht

2 Outline Recent interest rate trends Effect of interest rate environment on life insurance 2

3 The U.S. has seen a prolonged period of low interest rates 8% U.S. Treasury Rates 7% 6% 5% 4% 3% 2% 1% Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Date 10 year 5 year 1 year 90 day 3 Yield

4 The drop in interest rates has varied depending on position on the yield curve % Y ield % % % % July 2000 July 2001 July 2002 July % % % 9 0 d ay 1 y ear 5 year 1 0 y ear Term to M aturity 4

5 We have projected a range of 1000 future interest rate scenarios Arithmetic Average of Annualized T-bond yields over 10 years Best 5t h percent ile 10t h percent ile M edian 90t h percent ile 95t h percent ile Worst 0.0 Source: CAPLINK; Initial rate of 3.5%; normative rate of 5.2%. 5

6 The current low interest rate environment has had a significant impact on life insurance The impact has affected many different aspects of life insurance: Crediting strategy/investment strategy Pricing Product Low interest rates also impact regulatory requirements 6

7 The gap between portfolio based credited rates and new money rates has widened over the past 18 months, portending additional future rate declines Industry Credited Rates** Estimated New Money Credited Rate* /1/2002 4/1/2002 7/1/ /1/2002 1/1/2003 4/1/2003 7/1/2003 * Equal to 10-year Treasury bp (net pick-up) bp (spread) ** Source: Tillinghast Flash reports: Mean 7

8 UL credited rates also appear high in comparison to a defined competitor rate Rate (%) 6 5 Credited Rates Formula Year Formula = 3 6-month avg month avg of 5-year TR 8

9 As the disparity between portfolio rates and new money rates widens, companies may wish to consider changes to their crediting strategies Utilize new money or generational approach may significantly impact sales in today s interest rate environment protects in-force profitability (can decide where to set rate on in-force business) maintains broad equity among various issue periods Utilize a portfolio approach but move portfolio crediting rate down aggressively hurts new business sales, helps in-force profitability potential regulatory issues more... 9

10 As the disparity between portfolio rates and new money rates widens, companies may wish to consider changes to their crediting strategies (cont.) Utilize portfolio approach rely on inforce business to subsidize new sales have to be careful about danger zones minimum guarantees implicit interest rate guarantee in secondary guarantees increases exposure to rising interest rates 10

11 Potential changes to investment strategy Pick up additional yield longer duration, lower credit quality increase risk exposure exposure to interest rate risk could be mitigated by purchasing interest rate caps presumably risk/return tradeoff has previously been explored Invest shorter based on expectation that rates will rise creates earnings pressure (hopefully short-term) protection against falling/steady rates by purchasing interest rate floors more... 11

12 Potential changes to investment strategy (cont.) Protect yourself on future premium payments in low interest rate environment consider using swaps may be more appropriate in very low interest rate environment Derivatives availability: exchange versus OTC accounting treatment cost presume some infrastructure in place 12

13 Targeted ROI/ROEs have trended downward for the past several years ROI/ROE Target Values* Mutual/Fraternal (PAR OL) Stock (UL) ROI/ROE < % >15. Average 10-yr Treasuries** 72% 14% 14% 8.4% 77% 8% 15% 7.9% 8 13% 7% 6.6% 83% 17% 6.4% 82% 12% 6% 5.7% % 59% 35% 8.4% 26% 5 24% 7.9% 4 52% 8% 6.6% 45% 5 5% 6.4% % 43% 35% 9% 5.7% % 37% 5. In 2002, for the first time, no mutual/fraternal company targeted an ROI/ROE greater than or equal to 12% in 2002, and no stock company targeted an ROI/ROE greater than 15% *Results are based on primary profit measures and do not include the increase in equity returns that may be available through debt leverage. **The Average 10-year Treasuries are for the calendar year prior to the survey, as the survey is based on products priced in the previous calendar year. Source: Tillinghast Towers Perrin pricing methodology surveys; Federal Reserve. 13

14 We are seeing increased consideration given to interest rate risk in pricing Pricing actuaries are making explicit provision for cost of interest rate risk in pricing (e.g., 15bp on fixed annuities) Stochastic modeling techniques are increasingly being considered in pricing to quantify interest rate risk complicated by utilizing portfolio crediting strategy on new business 14

15 There has been a material shift in sales during the prolonged period of low interest rates Market Share of Individual Life Insurance Products by Product Type 2000 Q % 19% 18% 18% 19% 27% 22% 32% T e r m U L W h o le Lif e V U L Source: LIMRA Market Facts. Quarterly figures for variable life market share are generally higher than annual figures due to differing composition of companies that are reporting the results. 15

16 The product shifts have been driven by many factors not just low interest rates UL although available credited rates are low, they are higher than other comparable investments secondary guarantees may be more appealing in low interest rate environment Par WL portfolio rates embedded in dividend scale have dropped but are better than new money Term pressure for lower premiums continues VUL shift away from VUL driven by poor equity returns 16

17 The maximum statutory valuation interest rates are dependent upon the values of reference interest rates Reference interest rates are based on arithmetic means of monthly corporate bond yield indices published by Moody s Investors Service Reference interest rates vary by product type and guarantee duration. The reference rates are calculated using: The 12-month arithmetic mean for the period ending in June for some annuity products The lesser of the 12-month and 36-month arithmetic means for all life insurance products and other annuity products more... 17

18 The maximum statutory valuation interest rates are dependent upon the values of reference interest rates (cont.) The valuation interest rate is rounded to the nearest 0.25%. Results exactly between the two multiples of 0.25% are rounded to the lower 0.25% For annuity products, the new maximum statutory valuation interest rate is the rounded reference interest rate value For life insurance products, if the rounded value is not at least 0.5 different than the prior year s value, the maximum statutory valuation interest rate remains at the prior year s level 18

19 The maximum nonforfeiture interest rate is based on the valuation interest rate for life products Maximum nonforfeiture interest rates for life insurance products are calculated by multiplying the maximum statutory valuation interest rate by 125% The resulting rate is rounded to the nearest 0.25% Results that end up exactly between two multiples of 0.25% are rounded to the higher 0.25% There is a one-year grace period for nonforfeiture interest rate changes a new interest rate is optional for the following year but mandatory for the succeeding year 19

20 The maximum statutory valuation interest rate for 2004 issues of whole life insurance is 4.5 Period ending June 2003 corporate bond yield indices: 12-month mean of 6.71% (73 bp lower than last year) 36-month mean of 7.29% (41 bp lower than last year) Life products generally require large swings in yield indices before a change in the maximum valuation rate will occur Looking forward to 2005, the corporate bond yield over the last several months has remained relatively low: Month July, 2003 August, 2003 September, 2003 October, 2003 Corporate Yield 6.26 % 6.58 % 6.37 % 6.32 % 20

21 The maximum valuation interest rate could easily drop by 50 basis if interest rates decline even slightly Life insurance products generally require large swings in yield indices before a change in the maximum valuation rate will occur: Maximum Statutory Valuation Interest Rate in % 5.0 % Required 12 month mean July 2003 June % % 21

22 Conclusion What should the industry fear more? continued low interest rates rapid increase in interest rates Depends where you are portfolio vs. new money life insurance vs. annuities 22