How will the interest rate cut affect advisors?

by Nicolas Heffernan23 Jan 2015

The Bank of Canada’s (BOC) interest rate cut could be a case of short term gain but long term pain for life insurance companies.

“In the short-term, the balance sheets of life insurers may actually improve,” said IBISWorld analyst Stephen Hoopes. “Given the inverse relationship between bond prices and interest rates, falling rates tend to increase the value of an insurer’s bond investments. Yet, if interest rates were to remain lower-than-expected for an extended period of time, the investment returns of life insurers will be harmed.”

On Wednesday, the BOC surprised economists by dropping interest rates from one per cent to 0.75. Canadian life and health insurers have 41.9 per cent of their assets invested in fixed-income instruments, according to the Canadian Life and Health Insurance Association. “Consequently, life insurance companies are extremely sensitive to changes in interest rates, as they need to earn an adequate return on their investments in order to cover future claims expenses,” said Hoopes.

If interest rates remain low, many insurers may be forced to alter their investment allocation toward riskier assets. Alternatively, insurers may opt to raise prices in order to cover lost investment gains, which will affect advisors.

“Other things equal, rising policy prices tend to benefit insurance brokers and agents, as their commissions are often correlated with the total dollar amount of sold policies,” said Hoopes. “Yet, this assumes that the number of life insurance policies will not be negatively impacted, which is unlikely given worsening domestic growth prospects were to blame for the rate cut.”