Life insurance and the problem of low interest rates

When any economy crashes, there’s a moment of panic as politicians look around desperately for someone to rescue them. If no one is immediately forthcoming, they do their best to come up a solution. As an example of what not to do, we have the classic case of Cyprus. Faced with a bank crash, they decided everyone who had savings in those banks should pay towards the rescue. The reasoning is not bad. If the banks fail, no customer is safe. Bankruptcy means the creditors take what there is. If the banks have been using the customers’ savings for other purposes, the depositors lose everything. It’s therefore in their interests to pay up to 10% of their savings towards the rescue rather than lose everything. Except that’s political suicide. In 2008 when the recession hit around the world, there was a moment of panic, then banks were rescued using public funds and, after a few months thought, the central banks around the world began an aggressive policy of monetary stimulus. Essentially this means the central banks print lots of money and give it to their local banks at almost zero percent interest. The US Federal Reserve has recently confirmed it will keep the interest rates low until unemployment falls. The European Central Bank has pledged to keep cheap money flowing into the banking system for as long as is necessary.

We should be clear. There’s nothing wrong with this strategy. But it creates serious problems for the cheap life insurance market. When finding good returns on investments is easy, administrative costs can be cut to the bone. The pension income can be placed in more or less any investment and the return will appear. Now look at the markets. With the central banks offering money at near to zero percent, the returns on all investments made by companies and individuals have also fallen to one or two percent. Because most life insurance policies have a guaranteed minimum payout on death, this investment income is not enough to cover administrative costs and make a profit. The majority of cheap life insurance policies with guaranteed minimum benefits are therefore looking at losses unless they can find a way of improving investment returns.

This means recruiting investment managers and they command good salaries plus bonuses. The Insurance Commissioners and other regulators are growing alarmed life insurance companies may not have enough capital provision to meet all the claims. In Europe, the regulators are looking for ways in which regulations can be coordinated across all the member states and improve supervision of pension and life insurance companies. Unfortunately, the American regulators have been less active and they are not addressing the increasing gap between capital available and liabilities. Although this may not be a problem in the next five years for cheap life insurance companies, the longer the regulators do nothing, the greater the risk of bankruptcies.

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