How will commercial insurance be affected by rising interest rates?

With inflation at a 40 year high and looming interest rate hikes on the horizon, one might suspect commercial insurers are poised for a significant boost in profitability. Historically the correlation between insurance companies’ profitability and interest rates is linear, ie. insurance companies flourish with higher rates. This can ease upward pressure on premiums and result in rate decreases for policyholders, but is that the case this time?

Insurance remains an industry which, like any other, experiences its own unique market cycles. Insurers, which have steady cash flows, are compelled to hold lots of safe debt and maintain a strong balance sheet to pay claims on insurance policies they write. While property and casualty insurers strive to make a profit on the underwriting - that is paying out less premiums than losses - the investment arm of their business often determines their ultimate return. 

Since the financial crisis, many insurers have done well in the equity markets which allowed them to take losses on their underwriting business, keeping rates unsustainably low in real terms. In fact, average rates on commercial all-risks property barely increased between 2006 and 2016. But with flattening returns in the equities markets over the last five years, compounded by a significant increase in catastrophic loss events (ie. hurricanes, floods and wildfires) rates have been on the rapid rise.

Take a look at insurance providers such as The Allstate Corp. (ALL), and The Travelers Companies, Inc. (TRV) during periods of higher interest rates. Conversely, they don’t fare as well in low-rate climates because their underlying bond investments yield weak returns. With higher bond yields, insurers may receive an additional boost to their bottom line and be able to limit premium increases, right? 

.. well, that is only if inflation slows down. Inflation which was last recorded at 7.9% YOY in the United States and 5.7% in Canada (which doesn’t even take into account rent and mortgage costs). Premiums would need to keep up with inflation for insurers to maintain their current state of profitability, which is almost non-existent assuming all else remains equal. Couple this with the climate change causing more catastrophic events such as wildfires and hurricanes, and it doesn’t look like we will see a flattening on rate increases anytime soon.

‍