The finance world now waits with bated breath for this month’s Federal Reserve meeting, during which many are expecting a big announcement. The Fed is expected to raise the federal funds rate for the first time since the start of the recession, which has broad implications for the entire economy. While nothing is certain, some analysts, like Allianz economic advisor Mohamed El-Erian, peg the chances of a rate increase to as high as 70 percent. The consensus is that the Fed will raise interest rates on interbank borrowing. What that means for the insurance and financial services industry is a bit murky, however.
Long time coming
On one hand, higher interest rates are generally good for consumers who invest in long-term insurance products or securitized assets. In a report on financial professionals’ sentiments regarding interest rate changes, Cerulli Associates found a large number of professionals had long bemoaned the low rates which had plagued returns for their clients over the last several years.
“With such high-quality, fixed-income-oriented investment portfolios, the sustained period of low interest rates since the 2007-2008 global financial crisis has largely been detrimental to insurers,” Alexi Maravel, associate director at Cerulli, said. “While higher rates will be beneficial to insurers, we find insurers are also preparing for the how and when those rate increases come about.”
Changing investment patterns
For the past five years, insurers have had to make sweeping, and often risky, changes to the way they allocate investments. According to a study by Conning, Inc., due to consistently low interest rates, many insurers shifted their investments out of volatile stocks and into risky yet high-yield bonds. Many of these funds, like Schedule BA assets and low-rated bonds, satisfy insurers’ appetite for higher yields but expose them to greater credit risk. With a higher federal funds rate, and thus better returns on investments in general, insurers may begin moving away from these investments. In the meantime, though, this trend may mean trouble down the road for small- and mid-size insurers, who are not as well-equipped to take on undue credit risk, according to Conning’s study.
Ultimately, these studies show that a raise in interest rates should be generally good news for insurance professionals. However, some analysts, including El-Erian, think the rate will only increase by a quarter of a percent. It’s unclear whether this will be enough to increase yields across the board, as well as stave off appetites for low-grade bonds which have propped up the industry for some time.