The Federal Reserve’s perpetuation of near-zero percent interest rates has been a bane for the insurance industry. With the Fed keeping rates to 0% until 2015 at Thursday’s FOMC meeting, the insurance industry is really in a bind that will be difficult to overcome.
Consider that insurance companies have investment portfolios similar to those of public pension plans around the United States. To meet their obligations, they’re expected to earn a certain rate of return per year – maybe 8%. In a normal rates environment, you’d be able to buy some Treasuries and earn 3-4% off those instruments alone, meaning you wouldn’t need to put up a lot of risk in stocks and derivatives markets to earn the difference to 8%.
Instead, Treasuries are offering little-to-no return and continue to go lower. This forces the insurance company to look elsewhere for yield and it’s tough to find these days. The portfolio manager is forced to go further out on the risk curve in order to satisfy that 8% return; maybe he needs to buy some risky junk bonds or invest in some tech IPO that just hit the market. Or maybe he can’t because it’s simply too risky and there’s a need to preserve capital.
And should this happen, the company is really in trouble. Profits go down, jobs get lost and claims risk becomes heightened all because the investment portfolio can’t maintain this set percentage it has to meet. This is just one of the many problems (and effects) with the current interest rate policy at the Federal Reserve.