The historic vote this week on a non-binding referendum to determine whether the United Kingdom should leave or remain in the European Union has made headlines. The 52–48% vote, with a participation rate of almost 72% of the electorate, was in favor of exit by a 4% margin.
The fallout from this decision has been felt around the world, but how will it affect life insurance carriers and your life insurance policies? Unfortunately, the effect will probably be negative. The consensus is that the UK exit from the EU will harm the economy worldwide. The International Monetary Fund (IMF) recently estimated that Brexit could knock up to half a percentage point off the combined output of the world’s advanced economies by 2019. (1.)
The real issue for life insurance carriers is low interest rates, and this additional stress on the world economy means that we will probably not see rates rising any time soon. In fact, this week Fortune magazine reported that with the Brexit result, the chance of the Fed’s raising interest rates in the US “has collapsed to 0%.” Wall Street traders are “assigning a 10% probability to the Fed cutting interest rates at its July meeting and a more than 20% chance of a rate cut at subsequent meetings later this year and in early 2017.” (2.) This is not good news for life insurance carriers already struggling under the weight of historically low interest rates.
In the last year, we have reported often on the effects of low interest rates on policy performance. A quick review of past blogs will also provide a wealth of information on the Cost of Insurance (COI) increases we have weathered, which many believe was a direct result of depressed rates. Life insurance carriers invest the bulk of their Whole Life and Current Assumption Universal Life premiums in fixed investments. Even Equity Index Universal Life policies, the industry’s new darling, are invested in fixed investments. The credited returns to those policies are driven by options on an index purchased from the proceeds of that fixed investment. As long as interest rates remain at historic lows, there will be a drag on policy performance and financial pressures on the carriers.
McKinsey and Company published a report in November of 2013 detailing the effects of low interest rates on the economy from 2007 to 2012. They found that the biggest winners were governments and non-financial corporations. The biggest losers? Pension and other qualified plans and guaranteed and variable rate life insurance policies. In fact, the report noted, “Life-insurance companies, particularly in several European countries, are being squeezed by ultra-low interest rates, so much so that if this environment were to continue many of these insurers would find their survival threatened.” (3.)
That report was published almost three years ago, and things have not gotten better; they have gotten worse. Without positive changes in the current environment, I wonder what a report three years from now will find.
(1.) International Monetary Fund, IMF Country Report No. 16/169, June 2016
(2.) Fortune, The Fed is Now More Likely to Cut Interest Rates Than Raise Them, June 26, 2016
(3.) McKinsey Global Institute, QE and Ultra-Low Interest Rates: Distributional Effects and Risks, November 2013