Report examines insurers’ sensitivity to interest rates and inflation

The insurance industry is well positioned to benefit from moderately higher interest rates, concludes a report from DBRS Morningstar, entitled Canadian Insurers Well Positioned to Manage Rising Inflation Risk, Seen Benefiting From Higher Interest Rates, published Nov. 16.

In the report, which examines the impact inflation and higher interest rates might have on insurers, the report says rising inflation will be manageable for insurers, as higher costs are ultimately passed on to consumers.

“Above a certain level, higher interest rates may do more harm than good for insurers if they lead to an economic downturn with increased defaults and declining asset valuations,” the report states. “Both deflationary and runaway inflation scenarios pose additional risk to the industry.” 

The commentary goes on to say that rising inflation, meanwhile, can negatively affect Canadian insurers through higher operational and claims expenses, but products most affected by inflation, such as property and casualty (P&C) policies and group health insurance can typically be repriced in a relatively short period of time. They say higher inflation can also lead to higher interest rates which are typically positive for insurers over time.

Higher operational costs 

They warn that higher inflation can also lead to higher operational costs, affecting net income. “Insurers may have more difficulty adjusting premiums for higher operational costs than they would for claims, as competitive pressure will continue to reward efficiency,” they write. “Smaller-scale insurers, insurers with a weaker digital presence or insurers with legacy businesses that cannot be repriced will be the most adversely affected by higher operational expenses.” 

Short term earnings impacts of higher interest rates, they say will depend on each insurer’s asset-liability matching, accounting and actuarial methods used.

“There is also risk for insurers with investments in real estate and alternative assets, which may decline in market value under higher interest rates. Should interest rates rise too much, insurers could also experience additional defaults on their fixed income portfolios as debt becomes less affordable and the economy slows down,” they write. “The best-case scenario for insurers is one where central banks are able to control inflation with moderately higher interest rates without causing a major economic downturn.”