Low rates troubles for insurances and pension funds

A CGFS report highlights the pressure of a ‘low for long’ interest rate environment on life insurance companies and defined-benefit pension funds. This pressure reflects a fundamental mismatch: the duration of liabilities is greater than that of assets. Hence low rates (discount factors) have reduced funding ratios below 100% after the great financial crisis. Simulations suggest that funding ratios could decline further, possibly accompanied by negative net cash flows. A ‘low-for-long’ scenario would broadly make things worse. While the nature of this risk is well known, its manifestation is gradual and partly mitigated by the asset reflation of the 2010s. The worst scenario for insurance companies and pension funds is one where rates ultimately fail to rise or are pushed even lower (negative) due to new deflationary financial market shocks.