“The prolonged low interest rate environment” has become a mantra for many of the ills plaguing life and annuity companies in the post-recession era. Low rates are roundly blamed for hampering company investment returns, curtailing product design, cutting interest crediting, making mincemeat of guarantee riders and more.
But has the downward spiral finally run its course?
No market watchers are predicting rip-snorting jumps in rates next year. But signs are showing up that an interest rate floor may be forming or has already formed. That could be the precursor to the rising interest environment that many are looking for.
For instance, in the past several months, rates on 10-year Treasury Bills seem to have gelled south of 2 percent – about 1.6 percent or so, though it fluctuates a bit. This trend appears to have started in June, based on the trend line shown on Treasury’s online rate calculator.
This is worth noting, because insurers commonly use 10-year T-Bills when investing, evaluating pricing and engaging in other business activities. It’s a type of benchmark or bellwether. That’s in addition to the rates of corporate bonds (10- year AAA and 10-year AA), and other indicators.
What Experts Are Saying
Whether this seeming leveling-out of the 10-year T-Bill rate is the bottom that marks the beginning of a new stage in economic recovery is not yet being widely discussed.
The national preoccupation with the fall elections and then the fiscal cliff may have something to do with that. So, too, might the natural hesitation to announce a bottom in the face of continuing economic uncertainty.
But at least one analyst mentioned the possible bottom in a recent report. In the December issue of his firm’s Fixed Income Digest Research Report, Martin Mauro wrote that “yields have probably bottomed but we don’t expect a substantial rise.” Mauro is an analyst at Merrill Lynch Wealth Management, a business of Bank of America. He made the observation while discussing how bond market yields are “close to record lows just about everywhere.”
Mauro also noted that his firm’s rate strategists are expecting the yield on the 10-year Treasury to be 2 percent at the end of 2013. If that expectation proves out, that would mean the 10-year rates would be up roughly 40 basis points from where they were at year-end 2012.
This would be a razor-thin increase, but it’s significant for insurance people all the same – because it would be up, not down.
Standard & Poor’s is also expecting the baseline rates on 10-year Treasuries to rise – to 2 percent in 2013 from a 1.8 percent average in 2012, says Robert Hafner, a director at the New York firm. In 2014, S&P is projecting the average rates will rise again, to 2.8 percent, the same as in 2011.
So “T-bills could be bottoming out, though we generally don’t characterize it that way,” Hafner answers. “We are saying, rates are projected to go up gradually” from 2012.
David Paul, principal at ALIRT Insurance Research, a ratings firm, points out that the lowest 10-year yield ever over the last 50 years was 1.43 percent. That was in July of last year. Meanwhile, the highest was 15.84 percent, in September of 1981.
The average 10-year rate over the years is 6.65 percent, and the median is 5.27 percent, he says.
“Traditionally we have seen rates revert to the mean. So, unless we end up living in a totally different new normal world going forward – which of course is possible – the statistics say that we will revert upward in the future.”
Paul does not want to say that the floor on interest rates has already occurred or that rates are heading up right now.
That’s because rates could still go down, he explains – for instance, if the Federal Reserve continues its aggressive monetary programs and/or if geo-political disharmony spurs more people to seek the safety of federal bonds. Then again, he says, rates could go up. That could happen if the U.S. and global economy starts to recover and if the Federal Reserve eases its monetary policy in response.
In March 2012, the rate on 10-year Treasuries went up to 2.25 percent, points out Paul. “But that turned out to be a headfake and was short lived,” he says. “Still, since we will likely revert to the mean, statistically speaking, we can expect that, at some point, we are going to hump out of the low rate environment.”
Some insurance professionals notice small shifts involving interest rates but are hesitant to put a label on it.
For example, in November, most fixed annuity carriers held their interest rates steady, says Danny Fisher, publisher of the Fisher Annuity Index, Dallas, noting that the average rate for all products in the database at the time somewhere in the 2.5 percent to 2.6 percent range.
“That’s probably the first time that has happened in months,” he says.
Fisher is surprised by that subtle change – to “holding steady” – but he does not want to describe it as a sign an interest rate bottom is at hand. “I don’t know that rates won’t go down further,” Fisher explains, “and I don’t know anybody who does know that.
“Rates have been down for months; Federal Reserve Chairman Ben Bernanke keeps saying that the Fed will hold Fed Funds rates low into 2015; and no major insurance carriers have started raising their fixed annuity rates, so I don’t see anything to suggest otherwise.”
Some smaller carriers do come out with interest rate specials once in a while, Fisher allows. For instance, in December, one carrier was offering a fixed annuity with a 3 percent rate guarantee that was set to end in January. “But specials don’t necessarily mean a carrier is getting higher rates for its money,” he notes. “Sometimes they do that just to bring in a little more business, maybe to close out the year.”
What Could Happen
If rates go up: An upturn in rates would be positive for the life insurance industry, says S&P’s Hafner. The carriers seem to be astute at balancing the needs of the company with those of customers and distribution, and that will continue, he predicts. “Carriers will enhance product benefits consistent with the interest rate environment. You’ll see this reflected in their crediting rates, which will ebb and flow as their investment returns ebb and flow.”
If rates stay where they are now: Carriers that are affected by interest rates in any part of their operation will continue doing what they have been doing to manage through the prolonged interest rate environment, predicts Paul of Connecticut. “That is, they will continue repricing, product cutbacks, market exits, distribution curtailments, and other measures to stay viable and keep profitable.”
It will mean more tough times for carriers, too. For instance, Hafner points out that the investment yield on carriers’ portfolios has been dropping by about 20 basis points a year for the last two to three years, due to the low rate environment. “The longer that low interest rates persist, the more this will erode earnings,” he says.
Insurers offer guarantees that banks cannot, however, so the complex competitive dynamic between insurance and banking will continue, especially in the area of retirement products, Hafner says.
Some carriers are trying to make their products more fee-based and lessspread- based, he points out, explaining that “it’s hard to make money when the margins are only based on spread and interest rates are low.” Advisors can expect to see these products in the retirement market, where there will be more focus on asset-based fees, he said, and also in in the variable annuity market.
“Companies can’t entirely escape offering spread-based products,” Hafner allows, “but they do have to manage the long-term guarantees they put on their products.”
Some carriers might treat this period as an opportunity to take some risk, ALIRT’s Paul adds. “Perhaps they know something that they think other carriers don’t, or perhaps they are in a position to do what their peers aren’t doing. So they will compete in rate, products or other areas. If they get it right, they could grow market share. It happens in the fixed annuity world all the time.”
If rates fall further: Insurance companies do need to make a profit, says Paul. So, if rates fall even more than they have so far, some carriers may need to dial back what they are doing even further than they have already.
It is clear that interest rate uncertainties still abound. But if it turns out that rates really have bottomed out, the coming 12 months could bring sighs of relief plus glad hands at the drafting boards.