Traditionally it is thought that higher interest rates translates to higher profitability for insurance companies. Historically interest rates have been dynamic and fluctuated on a regular basis. However, for the last then years we have been experiencing a zero interest rate policy and yields on bonds have been super low. While insurers may be holding a significant portion of their portfolio in bonds, with the 10 year yield starting to rise at the end of 2021, the value of existing bond investments with significant long maturities may have started to fall. In other sections of the investment portfolio like equities, again the equity values have risen by almost 400% or higher in some cases but have had a significant pull back in Q1 of 2022.
Chief Investment Officers at insurance companies face a dilemma on how to structure their portfolios to manage existing insurance policies versus being competitive in offering new policies in higher interest environments where discount factors change where surrender risks for policies increase. On the other hand, with higher interest rates new policy holder signup hurdles increases as they have more alternatives to earn a higher rate and policies need to be sweetened.
Insurers that are able to be nimble and take higher risks upfront in terms of their portfolio structuring will be best placed to take advantage of the changing interest rate environment. Long maturity bond investments may need to be replaced with short maturity holdings as interest rates increase. Higher interest rates can wreak havoc to investment portfolios and the values of highly speculative and inflated assets could come crashing down which could make servicing benefits payouts challenging. The other challenge will be the net present value computations using higher interest rates