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Is lower interest rate good for Insurance companies?


muscleman
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- Insurance companies depend on net investment income to make up underwriting losses and also for paying claims.

- Low rates will show unrealized (and possibly realized) gains on the leveraged bond assets and large rises in book value , but this is temporary.

- When they go to renew expiring bonds that have appreciated (meaning yields are even lower), they will have less investment income.

- If unexpected rise in inflation and rates, they will suffer losses by locking in the lower yields. In higher inflation, claim costs increase too. It could suffer large losses.

 

Basically you have heard over the last 10 years how pension funds and insurance companies are suffering. That's because they can't make good investment income for their business operations without incurring more risk. Then if that risk is realized they will have a double failure and possibly go bankrupt. So it's a double edged sword too low interest rates.

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- Insurance companies depend on net investment income to make up underwriting losses and also for paying claims.

- Low rates will show unrealized (and possibly realized) gains on the leveraged bond assets and large rises in book value , but this is temporary.

- When they go to renew expiring bonds that have appreciated (meaning yields are even lower), they will have less investment income.

- If unexpected rise in inflation and rates, they will suffer losses by locking in the lower yields. In higher inflation, claim costs increase too. It could suffer large losses.

 

Basically you have heard over the last 10 years how pension funds and insurance companies are suffering. That's because they can't make good investment income for their business operations without incurring more risk. Then if that risk is realized they will have a double failure and possibly go bankrupt. So it's a double edged sword too low interest rates.

 

Thank you! Hmm..... I do have concerns for the inflation scenario. I guess that depends on how the investments are managed? If they are into stocks like Buffet does, then it should be fine in an inflation case but if they are in bonds then I guess it is a big problem.

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The single most important factor to evaluate is probably the duration gap.

 

Let's say you have long duration liabilities that are not indexed to inflation, or where the inflation index might not keep pace with increase in rates. And you have short duration assets of high quality. If rates unexpectedly increase your liabilities will shrink a lot. Your assets will be relatively unchanged in value. See here for a better explanation:

https://www.investment-and-finance.net/financial-analysis/d/duration-gap.html

 

There are companies that have vastly negative duration gaps and which will react quite positively to moderately increasing rates. Mostly life insurance but also some P&C insurers.

 

In the nordics the P&C insurers have largely been able to compensate decreasing investment returns with improved underwriting profits. My guess is many would do well initially if rates increase. Some claims will have inflation but also parts of the insurance book has capped sums and/or the premium is indexed to a sum which will be increased yearly in line with inflation e.g. the turnover of the business or replacement cost of a house.

 

 

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See now that the question was what would happen with decreasing rates.

 

Well. It depends on split of underwriting profit to investment profit. The investment profit might decrease a bit if reinvestment rates decrease, but it can be a slowish process depending on duration of investment book. A large equity position should be beneficial.

 

The value of the underwriting profit should react positively due to lower market discount rates.

 

So I would go for a low combined ratio with little volatility, would guess in a lower rate scenario they're gonna get more expensive relative to less quality books.

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If float is like the cost of money, then something like Berkshire is turbocharged, although with more volatility...But most insurers don't write so well as to have zero cost. Sometimes if they are not very good their cost of capital is even higher than prevailing interest rates to borrow the cash. It's a fine line between borrowing with interest and using float. I think an exceptional insurance operation will always do well, but you can't deny they are financial companies and definitely are vulnerable to seismic shifts in financial conditions.

 

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Guest cherzeca

See now that the question was what would happen with decreasing rates.

 

Well. It depends on split of underwriting profit to investment profit. The investment profit might decrease a bit if reinvestment rates decrease, but it can be a slowish process depending on duration of investment book. A large equity position should be beneficial.

 

The value of the underwriting profit should react positively due to lower market discount rates.

 

So I would go for a low combined ratio with little volatility, would guess in a lower rate scenario they're gonna get more expensive relative to less quality books.

 

I thought insurance companies tried hard to match fund, avoid duration gaps. 

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See now that the question was what would happen with decreasing rates.

 

Well. It depends on split of underwriting profit to investment profit. The investment profit might decrease a bit if reinvestment rates decrease, but it can be a slowish process depending on duration of investment book. A large equity position should be beneficial.

 

The value of the underwriting profit should react positively due to lower market discount rates.

 

So I would go for a low combined ratio with little volatility, would guess in a lower rate scenario they're gonna get more expensive relative to less quality books.

 

I thought insurance companies tried hard to match fund, avoid duration gaps.

 

Yeah I believe this is often the case. Especially in life insurers where interest rate risk is a major risk component from the time horizon of 12 months due to the discounting of long liabilities. 12M is the risk horizon for all models at least within EU/Solvency II. I guess it's the same in the US?

 

I work in a P&C insurance co and our risk is more closely tied to mark-to-market value changes of assets and variability in insurance losses themselves. Most risk models are pretty short sighted...and from what I've seen they don't incorporate how the business prospects changes in different market environments. It's all focused on the balance sheet. E.g. that people might not buy new cars to the same extent when the stocks have crashed is an effect not captured.

 

 

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See now that the question was what would happen with decreasing rates.

 

Well. It depends on split of underwriting profit to investment profit. The investment profit might decrease a bit if reinvestment rates decrease, but it can be a slowish process depending on duration of investment book. A large equity position should be beneficial.

 

The value of the underwriting profit should react positively due to lower market discount rates.

 

So I would go for a low combined ratio with little volatility, would guess in a lower rate scenario they're gonna get more expensive relative to less quality books.

 

Rings true & makes me think about BRK.

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Do lower rates allow insurers to charge higher premiums? Presumably lower rates = healthier economy, lower expenses in terms of mortgage/car payments etc, more consumers seeking insurance on additional assets (boats, RVs, vacation homes, etc.) if consumers have more money available to them are insurers able to capture it in terms of slightly higher premiums? Or does price competition between insurers erase any potential gains?

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In the nordics the P&C insurers have largely been able to compensate decreasing investment returns with improved underwriting profits.

 

That is interesting.

 

If one insurer tries to raise premiums to get better underwriting profits, it will only work if all the others do it at the same time. So this has to be either some regulatory rate increases or oligopoly where they all raise rates together. Do you know whats going on in the nordics?

 

Reminds me of the Canadian banks.

 

Can you give me some names of these insurers?

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