With interest rates still low by historical standards, the Federal Reserve may be preparing for a hike in the near future.
At its summer meeting, the Federal Reserve signaled its willingness to gradually raise interest rates. Although inflation remains low at 2%, Federal Reserve Chairman Jerome Powell said a slow rise in rates would keep the economy from overheating as wages increase.
“If the strong growth in income and jobs continues, further gradual increases...will likely be appropriate,” Powell said. At its latest meeting, however, the Fed didn’t move to change the benchmark rate from its current range of 1.75% to 2%.
According to CME FedWatch Tool, which forecasts Fed actions on interest rates, that may change. The Fed may increase rates to 2% to 2.25% in September, with the range rising to 2.25% to 2.5% in December. The Fed has also said it intends to raise rates three times in 2019.
Those hikes, if enacted, would lead to the highest rates in a decade — though they would still be low by historical levels. Yet for insurance companies, agents, and policyholders, any upswing in interest rates may be good news.
Stronger Insurer Performance
When interest rates rise, insurance companies benefit since they invest premium revenues in investment vehicles such as Treasury bonds. As bond revenue grows, insurers strengthen their overall financial position.
Higher rates tend to benefit policyholders and buyers looking at insurance products, as well. Low interest rates narrow the spread between revenues and return on investments. In an effort to make up for those lower revenues, insurers may decide to increase premium payments on new policies or contracts in place. Higher interest rates, therefore, permit insurers to keep premiums affordable.
Generally speaking, a strong economy boosts income for individuals (due to rising wages) and profits for small businesses. The Commerce Department’s Bureau of Economic Analysis recently reported U.S. households are saving more and have more disposable income in their wallets. For the insurance industry, this presents an opportunity to offer risk protection for new purchases, such as cars and properties.
Better Investment Returns
Rising interest rates also increase the attractiveness of investment-based insurance products. Specifically, fixed annuities and fixed indexed annuities perform better when interest rates go up. Fixed annuities, for example, are typically priced higher than CDs. If an upswing in interest rates cause CD rates to rise, fixed annuity yields will climb upward, too.
Meanwhile, fixed indexed annuities base their rates on a stock market index that typically advances as interest rates rise. Those higher interest rates then push up fixed indexed annuities performance. Since fixed indexed annuities cap the rate to protect against market downturns, however, policyholders may miss out on total market gains.
Touching Base with Clients
Agents that sell investment-based insurance policies may find prospects and clients asking whether it’s time to buy these products with the Fed considering increasing interest rates. While higher interest rates would benefit certain products, the Fed may opt against raising rates depending on how the economy shifts — or if trade tensions hamper growth.
Other factors must be taken into consideration regardless of what the Fed does. Independent of rates, the decision to purchase investment-based products should involve a client’s current financial situation, their tolerance for risk, and their income needs during retirement.