In the past year or so, we have highlighted the issues around the historic low interest rate environment, specifically the negative effect on insurance carriers and products. Since life insurance policy management is our focus here at ITM TwentyFirst, these issues are natural for us to cover.
Clearly, many life insurance policyholders are suffering due to the fallout from these low rates. So much so that I get emails every week from average consumers who have run across our blogs, and are looking for answers. So, who else is suffering and who is benefitting?
In our last Blog (See: Why Brexit Is Bad For Your Life Insurance Policy), we briefly discussed the reasoning, but today we will go a little deeper.
The easy answer – those who borrow, win; those who lend, lose. The biggest winners were governments and non-financial corporations – the biggest borrowers. According to the McKinsey and Company report cited in our last blog, between 2007 and 2012, “governments in the United States, the United Kingdom, and the Eurozone had collectively benefited by $1.6 trillion, through both reduced debt service costs and increased profits remitted from central banks….Non-financial corporations across these countries benefited by $710 billion through lower debt service costs.” (1)
For every winner there must be a loser, and besides life insurance carriers and pension funds, the greatest loser was the average family. The report notes “households in these countries together lost $630 billion in net interest income, with variations in the impact among demographic groups.” Families headed by individuals under age 55 benefitted slightly as they tended to be net debtors, but those who are older, tended to suffer. On January 3, 2007, the average rate for a 5-year CD in the US was 4.07%. However, on January 3, 2016, the rate was .86%. (2) For a retiree with $250,000 invested, interest income went from $10,175 to $2,150 – a large decrease.
Interestingly, the report concludes that the low interest rates may not have helped stock market investors, as “the impact of QE and ultra-low interest rates does not point conclusively to an increase in equity prices.” The report notes that the stock market rally since 2009 may just be “a recovery following a large overcorrection in equity prices…markets tend to overreact as an economy enters a recession, causing a steep decline in prices. After such a decline, it is quite usual for markets to climb back fairly quickly.”
Housing prices were also not affected “in a direct way,” according to the report, though it “may well have prevented an even steeper decline in prices, and they may have accelerated recovery in the housing market.”
The effect of low interest rates may have shifted the political debate on public debt in America. An article in the Wall Street Journal (WSJ) this week notes that in 2012, when the “election turned largely on how Washington would end a series of rolling budget crises,” the Democratic platform mentioned cutting the deficit seven times. The platform for this year’s convention never mentions the subject. (3) And the Republican platform mentioned the term deficit only three times; twice in reference to trade deficits, once in reference to a Balanced Budget Amendment. (4) The possible reason? The article notes that while “the national debt as a share of gross domestic product has more than doubled since 2007, to around 75%…net interest payments on the debt have actually declined.”
As mentioned, the low rates are helpful to governments, allowing those who are cash strapped to “reduce their deficits and potentially ease austerity measures”, according to a recent Wall Street Journal article (5). Spain just sold a bond with a negative rate, a first for them, but Germany, Japan and Switzerland, Sweden, Italy and the Netherlands have all issued debt with negative yields. In fact, the latest tally shows that 35 percent of all government debt among major countries is trading at negative interest rates. (6)
A well-known economist, currently a professor at Harvard and a former head of the Congressional Budge Office, recently said, “persistently low rates mean the desirable level of debt a country can maintain can be higher.” (7) Apparently, since high debt has not resulted in increased rates to date, the belief is it will not, at least in the near future. Some believe that the bigger deficits, if spent wisely, are actually beneficial to the economy.
With increasing government debt worldwide, there is little incentive for central banks and governments to attempt to raise interest rates. For those of us managing an asset that could use a little relief from these historic low rates, that relief may come later than anticipated.
QE and ultra-low interest rates: Distributional effects and risks, McKinsey and Company