How rising interest rates impact insurers’ investment decisions

Recent interest rate hikes aimed at curbing inflation, and the potential for more rate hikes next year, has the insurance industry keeping an eye on its investment returns.

But while the transition from a low-interest-rate environment to a higher-rate environment will create short-term challenges, it also creates a long-term opportunity, noted Gord Dowhan, CFO at Wawanesa Insurance in a recent Canadian Underwriter interview.

“Over time…higher interest rates can create an opportunity for us to increase our yield moving forward,” Dowhan said. “As bonds mature, it gives us the opportunity to invest at a higher rate.

“You’ve seen this experience in Europe and elsewhere, where they were at zero percent and negative interest-rate environments in some cases. Having higher rates is healthier than being in that environment [of extremely low or negative interest rates], and there’s definitely an opportunity for us to pick up yield and investment returns within our investment portfolio as those instruments mature.”

For an insurer’s portfolio, Dowhan noted a rising interest rate environment makes certain investment instruments more attractive. And his firm has some of these in place, including preferred shares, limited recourse capital notes, and floating-rate or variable-rate debt.

“We’re also looking at real estate and infrastructure investments. From a rate-reset, preferred-share perspective, this gives us the opportunity to increase our yield; the dividend yield resets regularly based on five-year government bond yields,” he said.

“In a rising rate environment, this gives us an opportunity to increase our returns. Floating-rate, or variable-rate, debt has become increasingly attractive as rates rise. We’ve invested in and will continue to invest in floating-rate debt and look for opportunities to grow our portfolio there.”

What’s more, Dowhan said that during high inflationary periods, real estate and infrastructure tend to outperform other asset classes.

“The underlying instruments within these products, leases and other revenues that produce revenue streams linked to inflation, is one reason why they typically outperform other asset classes during periods of high inflation,” he told CU. “So, opportunities exist for us to enhance our yield in the long term and continue to deliver value for our policyholders.”

This article is excepted from one that appeared in the August-September issue of Canadian Underwriter. Feature image by iStock.com/porcorex