The Sensitivity of Life Insurance Companies in Denmark to Low and Negative Interest Rates

Abstract

This paper chooses to look into the interest rate sensitivity of the life insurance companies and pension funds. Beyond the challenges of the low-interest rate environment, insurance companies are confronted with greater capital requirements under the Solvency II regulation. The companies also differ a lot in their characteristics. Some insurers have high interest rate guaranteed products, while others decrease the share of guaranteed products to the minimum. Therefore, we chose to consider different aspects which influence the development of the life insurance industry in Denmark. Explicitly, these are: the general development of the insurance industry; the duration mismatch between assets and liabilities; the overall sensitivity of the return on investments to the interest rates; and macroeconomic factors influencing liabilities. Investments in financial instruments give insurers opportunities to hedge against the volatility of the interest rates. The most common instruments in the hedging toolbox of insurers are bonds, shares and alternative investments. Hedging is necessary because insurers are particularly challenged by the long duration of their provisions. The fall in interest rates increases the duration of liabilities, which becomes greater than that of assets. In this project we consider how life insurance firms hunt for a longer the duration in their assets to match the duration of their liabilities. The analysis reveals that companies in the Danish sector exhibit a small degree of sensitivity to the fluctuations in interest rates, with some deviations between large and small insurers. Further in the project we investigate any possible relation among macroeconomic factors and the liabilities of the insurers. The results show that, at a macro level, only longevity was Granger causative in liabilities. The findings in this project are also discussed in relation with insights of the investment strategies of the insurers and spread/possible bias revealed in the analysis. The overall findings suggest that insurers chose an effective allocation of their investments to deal with the low interest rate environment. However, the big insurers might benefit more from economies of scale.