What high interest rates mean for P&C investments
The Bank of Canada announced it would raise interest rates to 5% in October to help control inflation, but the P&C industry warns those high interest rates can wreak havoc on insurers’ investment portfolios.
It’s not all doom and gloom, though. Stable, high interest rates have a possibility of generating favourable returns over time, experts shared during Canadian Underwriter’s 2024 Economic Outlook webinar.
Bond investments make up a large percentage of insurance companies’ investment portfolios because they generate more predictable returns than equities.
“We’ve just come through the worst two-year bond market cycle in the past 150 years,” Jordan Brennan, chief economist and vice president of policy development at the Insurance Bureau of Canada said. “The Bank of Canada went from 25 basis points, so a quarter of a percent, and ratcheted up to 500 basis points, or 5%.
“That has just wreaked havoc on investors,” he said. “On a mark-to-market basis, we’ve seen enormous destruction of value. And that showed up on industry performance.”
The industry’s investments took a huge hit last year. In 2021, the industry’s net investment income totalled $2.35 billion. But in 2022, it was only $156 million.
“It’s important to understand that when interest rates move in a big swing, fast, there’s all kinds of adverse impacts,” added Alister Campbell, president & CEO of Property and Casualty Insurance Compensation Corporation (PACICC). “And we have seen exactly that happen in Canada with the investment loss of the total industry last year, which is first time in PACICC’s record that we’ve ever seen the total industry portfolio generate that loss.
“But over time, stable, higher interest rates, that actually generate a real rate of return for the insurance companies, are not a bad thing at all,” said Campbell. “Getting to even a slim, favourable return on our bond portfolios, in real terms, takes some pressure off the obligation to have underwriting results as good every year.”
If interest rates do start to stabilize, the P&C industry could expect to see benefits sooner than others, Campbell added.
“We don’t hold long bonds as a big portion of our portfolio,” he said. “And we have a shorter time before we start turning over assets held to maturity, and buy more attractive deals. It takes years — not months — but the industry will start to see benefit from this much sooner than some others.”
That said, Colette Taylor, chief operating officer at Sovereign Insurance, emphasized that unreliable investment results make it more imperative to ensure good underwriting results.
“I know everyone’s felt that real disciplined return to underwriting,” she said, and “I don’t think that’s a bad thing that we focus on having a good underwriting results for the longevity of our industry.”
At the company level, high interest rates might burn clients, which then leads to claims volatility. Plus, trying economic times often means an increase in fraudulent claims.
Insurers must reconcile their need to double down on managing underwriting with how the economy is affecting their clients.
“For example, in the construction sector, if work has to halt…if there’s certainly no money for being able to continue with those projects…how are coverages going to respond to that?” Taylor posed.
Feature image by iStock.com/utah778
