The Financial Supervisory Commission’s (FSC) downward adjustments to life insurance companies’ liability reserve interest rates is credit positive, as it would help reduce their risk of incurring negative interest spreads, Moody’s Investors Service has said.
The commission on May 12 reduced life insurance companies’ liability reserve interest rates, which are also known as discount rates, by 25 to 100 basis points for insurance policies to be sold after July 1 to reflect aggressive interest rate cuts at home and abroad.
Insurers use the rates to discount their projected benefit payments and determine needed reserves. A lower rate would require a higher reserve.
If premiums are insufficient to cover reserves at policy inception, the shortfall would weaken insurers’ earnings, Moody’s said in a report on Wednesday last week.
“We expect insurers to either raise premiums to cover the extra reserves or reduce benefit payments in order to maintain at least the same level of profitability,” it said.
New policies with lower returns for policyholders would also reduce insurers’ risk of incurring negative spreads when their investment income is likely to weaken from a prolonged period of low interest rates, Moody’s said.
The recent rate cuts by major central banks to mitigate the economic impact of the COVID-19 pandemic has significantly reduced insurers’ bond investment yields, the ratings agency said.
With lower returns for policyholders, insurers would also feel less pressure to invest in risky assets to meet committed returns, thus improving their asset quality, it said.
The rate reduction would also encourage insurers to extend premium payment terms on new policies, Moody’s said.
The adjustments would reduce the already low reserve discount rates on some short-term policies to close to zero for euro-denominated policies and drive customer demand to longer-term products that could still bear acceptable returns, it said, adding that the change would improve insurers’ product margins and premium stability.
The rate reduction reflects a proactive stance by the regulator to reduce stress on insurers from prolonged low interest rates, Moody’s said.
It came outside the annual adjustment cycle, suggesting that the commission is keen to rein in mounting negative-spread risks, the ratings agency said.
The reduction would depress new premium sales due to policyholders receiving lower returns, Moody’s said, adding that small to medium-sized insurers with heavy reliance on short-term payment policies would take a harder hit.
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