1. 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

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

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

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

5. Historical Analysis

6. Current 10-year Government Bond Yields
Source: Investing.com

7. Historical 10-year Government Bond Yield
Source: Investing.com

8. Historical 10-year Government Bond Yield
Source: Investing.com

9. Historical 10-year Government Bond Yields
Source: Investing.com

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

11. Historical 10-year Government Bond Yields
Source: Investing.com

12. Economic Theory

13. 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

14. 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

15. Impacts

16. 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

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

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

19. 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

20. THANK YOU!!!