The current low interest rate environment has been blamed by insurers for price increases in long duration fully guaranteed products and even the withdrawal from the market of certain offerings. When interest rates eventually go up, will this situation change? That was a question that Mary Grant, vice president, Financial Strategic Initiatives, for the Canadian division of Manulife Financial, addressed at the Insurance and Investment Convention in Montreal last November.Not unless insurers all get a case of “unbelievable corporate amnesia,” she said. “Even if interest rates go back up again, I think the Canadian insurance industry is going to be looking at different products.”
A key reason is volatility. “The past two years have shown insurers that they can’t be complacent about assuming what interest rates are going to do.”
For example, if interest rates improve to 8%, writing permanent products with the assumption that this rate would last forever would be a big mistake. Down the road, if the rates drop to 3%, the policyholder would be getting a fantastic deal but the insurance company would suffer and show huge losses, she explains.
“You can’t say that interest rates are looking fine now but if interest rates go down we’ll worry about it in the future. Because what you’ve done is you’ve written a whole block of business that essentially has now got this extreme volatility and is essentially underpriced.”
During her presentation, Ms. Grant detailed how current reserving calculations lead to volatility in insurers’ financial results.
For example, the interest rates that must be used as an assumption in calculating reserves are the rates in effect at the last minute of the last day of each quarter. Whether rates go up or down, this contributes to volatility and insurers’ financial results may swing from large profits to losses from quarter to quarter. This is part of the reason why long duration products – which require heavy reserving to back the guarantees – are less in favour among insurers.
“I do think this is a situation where companies are having to really think through what type of products and what type of risks do they want on their books, not just today but in the future and that’s why I think you’ve got this dichotomy. You’ve got some companies who are still in the business (of long-term fully guaranteed products) but are raising premiums, and you’ve got some companies who said, ‘Doesn’t matter what I can charge for this, I actually don’t want this type of business on my books.’”
As a result of this volatility, Ms. Grant says she believes that the products sold in the future will not be the same long duration fully guaranteed products sold today.
For guaranteed products, some insurers might be looking at selling products that have a shorter duration, that end at age 60 or 65 instead of going on forever, she said. They may also be looking at adjustable products. And, some may raise pricing to be assured – to the extent that they can – that what they’re charging is appropriate for the risk they’re taking on.
Meanwhile, some companies have just made the decision to not sell long duration guaranteed products such as Term to 100, universal life and critical illness and focus instead on shorter duration and adjustable products.
“I think we’re kind of at a watershed on this as an industry in Canada. I really think we are and you can see companies doing both of those things. You see companies going ‘If it is guaranteed I’m going to charge more, more, more’ or you’ve got companies saying ‘I don’t want to sell it anymore. I’m just not going to sell it.’”
Concern over investment risk – another factor contributing to volatility in financial results – has caused insurers to adjust their segregated fund products, said Ms. Grant. They are selling seg fund products with less investment risk, lowering guarantees, hedging market risk and ensuring that the price charged is appropriate for the risk the company is taking on and for the cost of the hedges.
“Some companies, again, may say, ‘You know what, we’re just not going to sell that stuff. It’s too volatile,’” she added.
One advisor in the audience asked Ms. Grant if she thinks consumers are ready to buy adjustable products and whether advisors are ready to market them? “This is the $64,000 question,” she replied and the answer will depend on the difference in pricing.
“If the difference in premium is not very big then you’ve got this issue of people will go for the guarantees.” However, if companies price appropriately for interest rate risk and the volatility risk, then she believes there will be a bigger difference between a guaranteed premium and an adjustable premium.
There is also a possibility that the industry could end up in a situation “where all of the companies – one-by-one and not in collusion at all – just decide that they’re not going to write that guaranteed business…You can’t sell it, or you can’t buy it if no one offers it.”