The topic of interest rates seems like a straightforward one but can throw up serious questions for actuaries and have large impacts on financial services businesses. The 2021 All-Actuaries Summit Plenary session ‘The lowdown – living in a long-term, low-rate world’ explored these questions in a broad-ranging panel discussion, chaired by actuarial doyen John Trowbridge. Panellists were Nicki Hutley, Hugh Miller and Greg Bird.
Nicki Hutley led off the session, giving an economist’s perspective. She discussed the ‘lower for longer’ nature of the current interest rate environment. She also covered some of the important recent developments; while short rates remain near zero, there have been increases in longer-duration bond yields and inflationary expectations. She noted the role of low wage growth and a lower target for unemployment as factors supporting low interest rates in the medium term. However, there is always the risk of complacency around the impacts of loose monetary policy and large fiscal stimulus around the world, so we cannot simply assume rates will stay ultra-low forever.
I also presented, perhaps because someone noticed my unhealthy obsession on inflation and discount rate assumptions. I focused on the liability side, noting that low interest rates have led to large increases in liabilities, such as long-term insurance costs. For organisations that have not been well-matched on the asset side, this had led to significant financial stress and lower solvency ratios. Current rates have room for both upside and downside risks, so matching will continue to play an important role in the future. There are also some regulatory implications; tools such as interest rate stress tests were not designed with an ultra-low rate environment in mind.
Greg Bird presented on the role of low interest rates supporting high asset prices across the board, termed the ‘everything rally’. Negative real yields (cash returns less than the rate of inflation) are a strong motivation to buy into other wealth assets. The high level of intervention by central banks in money markets can lead to uncertainty in estimating where long-term rates are likely to end up. In some cases, markets can be driven by expected interventions by central banks, rather than the underlying economic events that they are responding to.
The subsequent Q&A traversed a wide variety of topics. We discussed:
- the need ultimately for budget repair, and the potential for borrowing costs rising for the government if rates do rise;
- the risks of ‘wishful thinking’ in actuarial assumption setting, where the temptation is to counteract interest rate effects with other assumptions, such as inflation. This can have the effect of delaying recognition of unavoidable changes if rates are genuinely going to stay lower for longer;
- the alternatives to risk-free rates. While the panel agreed that risk-free rates for liabilities are the right way to perform valuations there are other contexts, such as strategic asset allocation and pricing, where different rates have value;
- one point of debate on the panel was around the degree to which ultra-low rates are cyclical versus structural. Nicki noted caution around predictions that real interest rates will stay close to zero, or even stay negative, long term. I’m fairly convinced that a range of factors have pushed the neutral interest rate lower;
- the challenges for some areas of financial services, such as retirement incomes, that are heavily affected by low rates. People reaching retirement age can no longer rely on income streams from low-risk investments such as term deposits, and so have to consider alternative retirement strategies.
Low interest rates have been a topic that affects most actuarial work. An extreme monetary policy environment will continue to throw up challenges for actuaries and the organisations they work for.
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