Insurance industry to reduce par policies' illustrative rates of return

Singapore

AN ENVIRONMENT of persistently low interest rates has prompted the insurance industry to reduce the illustrative rates of return used for participating (or "par") policies.

The Life Insurance Association (LIA) said on Wednesday that the upper bound for par policies' projected rate of return will be reduced from 4.75 to 4.25 per cent; the lower bound will be revised from 3.25 to 3 per cent.

These rates, which kick in on July 1, are used in benefit illustrations for par policies at point of sale. The last time these illustrative rates were reduced was in 2013.

The LIA stressed that the lowering of the illustrative rates does not have bearing on the actual return of an insurer's par fund nor on the return of existing and future par policies.

There is a possibility, however, that insurers may reprice or redesign their product lineup.

Said the LIA: "Some life insurers may take the opportunity to review and redesign the product features of their offering, since they have to make changes to policy illustrations and, accordingly, policy benefits and premiums may be changed for new products going forward."

It said consumers should not feel pressured to buy a new par policy before July 1, since the revisions to the illustrative rates have no impact on actual par policies' returns.

LIA president Khor Hock Seng said in a statement that the revision is "primarily in consideration of the sustained low interest rate environment".

"Our objective in doing so is to provide consumers with a more realistic range of projected investment returns, so individuals can make better informed decisions. Importantly, consumers must recognise that these upper and lower illustration rates are for illustrative purposes only."

"We strongly encourage individuals to engage with their financial advisers to decide on policies aligned with their personal needs and risk profile."

In par policies, premiums are pooled together and invested collectively by the insurer. The returns that accrue to policyholders comprise guaranteed and non-guaranteed components. Returns are "smoothed", which means that in a poor year, an insurer may choose to maintain its promised bonus rate. In a good year, it may distribute less of its surplus, holding some in reserve to be paid out when the experience is poor.

Par policies typically comprise the bulk of new business premiums. In the first quarter, par plans had a 46 per cent share of total new business premiums.

Insurers' life funds are mainly invested in fixed-income assets. In 2019, life funds' allocation into bonds ranged between 56 and 68 per cent, and equities' share was 15 to 29 per cent. The Singapore government 10-year bond is currently trading at around 1.5 per cent.

Eugene Leow, rates strategist at DBS Group Research, said: "Cyclically, we think that SGS (Singapore Government Securities) yields can track US Treasury yields higher when the Fed communicates a taper later this year. However, we do think that the bulk of the adjustment may have been done in Q1 already. The next leg should be more moderate.

"Structural issues are also important for the insurance industry, as they depend on longer-term assets to match their long liabilities. Yields at these levels, unfortunately, are still very low compared to what we saw just a few years ago."

Frances Cheung, OCBC's rates strategist, said yields are likely to be "grinding up gradually" as domestic economies recover.

"Increases in SGS yields are likely to be milder than expected increases in US Treasury yields. We expect the 10-year SGS yield at 1.7-1.8 per cent towards year-end, 20 basis points lower than our expected 10-year US Treasury yield."

Insurers grapple with a number of risks. One is a mismatch between the assets they invest in and their long-term liabilities, due to the dearth of very long-dated bonds. This mismatch further exacerbates the reinvestment risk, as monies are reinvested in ever-lower yields.

Still, recent and longer-term par fund performance has been strong, well in excess of the upper bound of the current illustrative rate of 4.75 per cent.

Based on a compilation by Finapac Research, as reflected in a Straits Times report last year, the geometric average of net investment returns over 10 years (2010-2019) ranged between 4.42 and 6.21 per cent.

In 2019, insurers' par funds made a strong showing, with net returns of 9.5 to over 13 per cent, based on a compilation of nine insurers by The Business Times.

Still, three insurers - AIA, AXA and Tokio Marine - opted to cut bonus and dividend payouts. Returns in 2018 had been mostly negative.

Two insurers which have published their par fund results for 2020 - Income and Prudential - report a strong showing for their par funds.

AIA said its par fund was bolstered by "favourable equity performance and higher fixed income returns". Great Eastern also indicated a "fairly good result".

Income reported a net investment return of 9.14 per cent, compared to 9.59 per cent in 2019. On the outlook for 2021, it said accommodative monetary policies across major central banks will continue to suppress bond yields at historically low levels.

It said that while risk assets are favoured, they are trading at rich valuations, making them vulnerable to short-term corrections.

"This, coupled with the persistent low interest rate environment, may present challenges to the fund's investment returns over the years."

Prudential said it would reduce terminal bonus rates for some whole life policies. Its 2020 par fund return of 5.65 per cent for Sing dollar products paled in comparison to the 2019 return of 12.26 per cent. It said it will maintain its projected reversionary bonus rates.

"The market sentiment for long-term interest rate levels will be driven by the economic growth outcome and inflationary expectations which remain areas of focus. Terminal bonus rates for most whole life policies will be maintained for the financial year 2020; however, some whole life policies will see a reduction in terminal bonus rates," it said.

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