Falling Interest Rates 12th Seminar on Current Issues in Life Assurance (CILA) Falling Interest Rates Setting the Context 20 February 2017 Mumbai Indian Actuarial Profession Serving the Cause of Public Interest

Where are interest rates headed? Will interest rates in 2017 be: Around 7% Higher Lower www.actuariesindia.org

Where are interest rates headed? Will interest rates in 2018 be: Around 7% Higher Lower www.actuariesindia.org

Where are interest rates headed? Will interest rates in 2022 be: Around 7% Higher Lower www.actuariesindia.org

Historical Analysis www.actuariesindia.org

Current 10-year Government Bond Yields Source: Investing.com www.actuariesindia.org

Historical 10-year Government Bond Yield Source: Investing.com www.actuariesindia.org

Historical 10-year Government Bond Yield Source: Investing.com www.actuariesindia.org

Historical 10-year Government Bond Yields Source: Investing.com www.actuariesindia.org

Historical 10-year Government Bond Yields Source: Investing.com www.actuariesindia.org

Historical 10-year Government Bond Yields Source: Investing.com www.actuariesindia.org

Economic Theory www.actuariesindia.org

Determinant of long-term interest rates Central Bank’s actions determine long-term interest rates through short-term interest rates and various monetary policy measures Investors extrapolate present and past in developing view on long-term outlook Change in short-term interest rates crucial determinants of change in long-term interest rates - John Maynard Keynes Investors oversensitive to near future due to uncertainty / ignorance of the more remote future Investor susceptible to mob psychology – Subject to waves of optimism and pessimism Investors prefer short term securities when short-term interests are high, but willing to shift to long term securities if short term interest rates fall – This quest for yields maintains balance Source: Working Paper No. 834, Levy Economics Institute of Bard College www.actuariesindia.org

CPI inflation the crucial driver for long-term interest rates!?! Empirical evidence Around 90% correlation between repo rate and 10-year government bond yields in India over the past four years RBI targets CPI inflation - Around 60% correlation between repo rate and CPI inflation in India over the past four years CPI inflation the crucial driver for long-term interest rates!?! CPI inflation in India is quite volatile Source: Investing.com, RBI website www.actuariesindia.org

Impacts www.actuariesindia.org

Investment Strategy Does ALM become even more relevant Will insurers be forced to make riskier investments Is liquidity risk an opportunity Are current risk management frameworks adequate Management of current guarantees Can derivatives be used increasingly Risks from subsequent increase in interest rates www.actuariesindia.org

Products Product mix Product design – Reduced investment surplus Competition with other financial products Change in demand trends and feasibility / risks Product innovation www.actuariesindia.org

Operational impacts Profit margins Expense loadings Policy case size Frequent re-pricing Persistency Lower inflationary pressures www.actuariesindia.org

Others Impact on insurance company valuations Impact on valuation interest rate – Level and computation Impact on solvency, especially under a RBC regime - Including impact on backing free assets Impact of Ind-AS implementation – Realising MTM impacts on P/L www.actuariesindia.org

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