Insurance companies are major investors in government bonds, which historically offered low-risk fixed income and provided cash flow stability and security, on short tail risk (non-life) while being fundamental to long-term liability products in life insurance.

Amid a post-pandemic recovery and recent economic instability, insurers have been hit by dramatic increases in inflation and interest rates. The impact on the bond market has been a reversal in US and UK long-run yield rates that has created both major challenges and new opportunities for the (re)insurance industry.

Professor Ricardo Reis (London School of Economics) explores the recent history of the global bond market, future scenarios for where yield rates could be heading and how these could impact (re)insurer balance sheets.

Key Findings

  • Rising interest rates have fuelled US and UK government bond yields to rise sharply in the last two years, reversing a previous 20-year decline.
  • Current quantitative modeling on longer-term bond yields rates suggests a permanent increase in long-term yields of 1%-2%.
  • Contrary to what most financial observers predicted, long-run yields have been sustained and haven't fallen away as central banks reach the peak of policy interest rates in their fight against inflation.
  • Factors driving the increase in long-term yields are complex and multivariate, including an increasingly aged population in Western economies saving money for their retirement, the decreasing appetite from emerging economies to continue to invest in the US bond market, concerns about the safety and liquidity of government bonds, and a post-pandemic increase in public investment projects.
  • Current conditions create both significant opportunities and challenges, particularly for life insurers. Advantages include potentially higher illiquidity premiums, tying up capital for longer periods, a growth in asset intensive reinsurance and high investment yields. Disadvantages include increased lapse risk of policies and stressors on capital positions, such as stability and profitability.