Life insurance: 6 things to expect in 2014

December 17, 2013 at 02:37 PM
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For life insurance professionals who have long had difficulty selling interest rate-sensitive insurance products because of abysmally low yields, 2014 should bring welcome relief. Interest rates are due to rise — and stay on an upward path through 2018.

This forecast, part of a wide-ranging industry outlook, was one of several predictions made by Alliance Bernstein Chief Investment Officer Douglas Peebles, who presented the kick-off morning session of the company's 2013 Insurance Symposium in New York City on December 5th.

The all-day gathering, attended by life insurers' home office investment professionals, examined the opportunities and challenges that carriers will face as they seek to implement long-term investment decisions and optimize risk-adjusted returns. The following is a recap of key developments Peebles said to expect next year.

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1. Fed's tapering will happen in March.

A major factor underpinning the rise in rates, said Peebles, are market expectations over the Federal Reserve's plans, announced by Fed Chairman Ben Bernanke earlier this year, to "taper" or pull back from the monetary policy known as quantitative easing. The latter aims to stimulate the economy by having the Fed purchase assets of longer maturity than short-term government bonds, and thereby lower longer-term interest rates.

A third round of quantitative easing, QE3, was announced in September of 2012. Then in June, the Fed disclosed plans to reduce its monthly bond purchases to $65 billion from $85 billion. But on September 18, the central bank postponed the reductions. When polled about a likely resumption date, most symposium attendees indicated next March.

Image: Federal Reserve Chairman Ben Bernanke attends the opening of the College Fed Challenge National Finals at the Federal Reserve Board of Governors in Washington, Monday, Dec. 2, 2013. The team competition for undergraduate students analyzes economic and financial conditions and formulate a monetary policy recommendation, modeling the Federal Open Market Committee. (AP Photo/Jacquelyn Martin)

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2. Yields on Treasuries will rise to 5 or 6 percent by 2018.

Regardless, Peebles noted, the market's concerns about tapering are already having an impact, draining money from bond funds — and boosting interest rates. This year, the five-year forward rate on five-year Treasury notes increased to 4.5 percent from three.

A chart displayed by Peebles forecasted yields on five-year Treasury notes rising to between 5 and 6 percent through year-end 2018. Tapering also is expected to impact the Federal Funds rate — the interest rate at which depository institutions actively trade balances held at the Fed— as yields rise from just below one percent currently to a forecasted four percent by year-end 2018.

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3. Positive returns on T-bills are expected through 2018

As rates rise, said Peebles, insurers can look forward to continuing positive returns on U.S. Treasuries, including 5-year notes (a projected 1.5 percent total return at year-end 2018), 10-year notes (1.36 percent) and 30-year notes (0.27 percent). Peebles expressed concern, however, about the impact of rising rates on asset prices.

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4. Tapering will be bad for asset prices, capital markets

The three previous rounds of quantitative easing, which pumps more money into the economy, resulted in increased asset prices — a component of a well functioning economy. Should the Fed make good on its tapering plans, asset prices could fall, thereby reducing growth.

Peebles observed that key drivers of the asset prices are reflected in the U.S. Broad Price Index, an inflation benchmark that integrates the consumer price index, several producer price indices, the S&P 500, plus prices of new homes and existing homes. These last two measures, which have risen by 12.7 and 10.2 percent, respectively, during the year past, could be significantly impacted by the Fed's tapering.

Should the Federal Reserve implement tapering solely on the basis traditional inflation measures like the CPI and PPI, and ignore the effect on housing, then, Peebles warned, the central bank risked negatively impacting financial markets — markets that have had an increasingly outsize influence on the real economy.

Image: This March 27, 2009 photo shows the Federal Reserve Building on Constitution Avenue in Washington. (AP Photo/J. Scott Applewhite)

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5. Volker rule will be good for life insurers

Also of concern to market participants, said Peebles, is the pending implementation of the Volker rule, named for the former Federal Reserve chairman who proposed it and enshrined in the Dodd-Frank Wall Street reform act of 2010. The rule's final wording, approved by five federal agencies on December 10, would ban "proprietary trading" or speculative investments that do not benefit the banks' customers. Though not part of the original proposal, the rule also requires bank CEOs to annually attest to regulators that their financial institution "has in place processes to establish, maintain, enforce, review, test and modify" a program to monitor compliance with the rule.

Peebles cautioned that the rule will result in less liquidity, making banks more vulnerable and less able to fund the capital requirements of the real economy. For life insurers, however, the Volker rule has a silver lining, for they can fill the liquidity gap and make a tidy profit in the bargain.

"You all have big balance sheets — be prepared to use them," said Peebles. "In times of illiquidity, [life insurers] should be able to make oodles of money by providing liquidity when it's needed and by taking a longer-term time horizon when investing."

Image: Former U.S. Federal Reserve Chairman Paul Volcker says a few words at a microphone in the lobby of the United Nations, Thursday, Feb. 3, 2005, in New York. (AP Photo/Kathy Willens)

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6. Insurers will get a lift from the economy

Insurers' sunny prospect will be buoyed by an expanding American economy and continuing low inflation. Peebles said that AllianceBernstein remains bullish on the U.S. and anticipates that gross domestic product will increase by 3.6 percent through 2014, a rate that will outpace that of other developed economies.

Underpinning the expansion will be (Fed policy notwithstanding) a continuing recovery in the U.S. housing market, healthy corporate profits and household interest payments, plus continued growth of the private sector and stable prices.

Image: In this, Tuesday, March 12, 2013, photo, a sold sign is posted in front of a home for sale in Mariemont, Ohio. Average U.S. rates on fixed mortgages edged up this week. (AP Photo/Al Behrman)

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