GoFigure: The Impact of Lowering Interest Rates on the Insurance Market
Today October 17, 2024, the European Central Bank (ECB) reduced its key interest rate to 3.25%, continuing a series of cuts to address economic weakness. The U.S. Federal Reserve, in its September meeting, similarly cut the federal funds rate by 50 basis points to a range of 4.75%-5%. Wall Street is anticipating more rate reductions in the near future.
What does this have to do with insurance? Everything.
As interest rates decline, albeit more gradually than their sharp rise that began in March 2022, the investment income (or "carry") that insurers rely on will shrink. This will inevitably affect profitability. To maintain margins, underwriters will become increasingly selective, eliminating underperforming risks—a process accelerated by advances in AI. With AI’s growing role in underwriting, we are likely to see fewer human-driven decisions, leaving little room for the broker-driven “favors” of the past.
Declining interest rates will also drive capital toward alternative investments in search of higher yields, like litigation funding. As the gap between Treasury yields and litigation finance returns widens, money will flow into this high-risk asset class. This, combined with progressive judges and changing cultural perspectives, is a key factor fueling "social inflation"—the rising cost of insurance claims.
Furthermore, the firm-hard market is likely to extend. Market-favorite MGAs, historically rewarded for fee generation over underwriting performance, are now under scrutiny. Legacy markets are reporting troubling underwriting losses from programs they manage. Tighter controls and more stringent oversight on MGAs will become necessary, especially as investment income weakens with rate cuts.
Lastly, a host of global factors—from political instability and elections to geopolitical tensions and natural disasters—are compounding risks. Even as underwriting standards improve, these external challenges will keep pressure on the insurance market. Caution is the word of the day, and rates are likely to remain firm-hard.