Ruben A. Gely and Ruben N. Gely, president and CEO of IICG respectively, discussed the impact of interest rate hikes on captive insurance companies via a recent company webinar.
The webinar looked at how interest rates affect the investment and operational aspects of a captive.
The federal interest rate is the interest rate at which banks and other depository institutions lend reserve balances to other banks. The U.S. Federal Reserve influences this rate to control inflation and stabilise the economy.
A.Gely said: “Interest rates affect captives in the same way as it would any other individual or industry. The current state of interest rates currently stand at 5 per cent to 5.25 per cent as of 3 May. This is the 10th rate hike since last March, making this cycle the fastest in history.”
Federal interest rate hikes mainly impact three areas of captive insurance companies: underwriting and pricing decisions, investment income and solvency and financial stability, according to A. Gely.
N. Gely said: “Increased inflation may instigate stricter underwriting standards. Given the increased cost of traditional insurance,. Captive insurance companies should also adjust their claim reserves and pricing strategies. We think this is actually an opportunity for captives.”
He went on to say: “In the short term, interest rates can increase the investment income for captives. Although due to Asset Liability Management considerations, we should not invest all our assets in the short term, and invest in the medium and long term.”
“However, Tthe value of existing bonds may decrease given the inverse relationship between bond prices and interest rates. Solvency is maybe the most important dimension. Inflation can increase operational costs and elevate the nominal and present value of liabilities due the to potential rise in claim costs.”
“Increases in costs should be considered properly in the analysis of a captive. We always recommend the pricing of the captive to be informed supported by a formal actuarial analysis.”
Given the potential impacts of interest rates, A. Gely and N. Gely recommended that captives should be proactive in their risk management and investment strategies.
This includes diversifying a captive’s investment portfolios, maintaining adequate capital buffers, implementing asset-liability management strategies, and regularly stress-testing their financial resilience against interest rate changes.
IICG is a Puerto Rico-headquartered insurance consulting and management firm, specialising in captive insurance.
