Insurers’ Conundrum: Higher Book Yields at the Cost of Shrinking Unrealized Gains

 "There’s no such thing as a free lunch."

– Milton Friedman

The federal funds rate is on the move after nearly a decade at the lower bound. For eight years, insurance companies waited for a higher rate to stem the erosion of book yields and the end looks to be in sight. While higher reinvestment rates may be welcome, it comes at the cost of dwindling unrealized gains.

At Standish, we are discussing long-only strategies with insurance clients to seek to monetize portfolio gains and minimize the impact of rising interest rates. At the extreme, significantly shortening duration or moving to all cash can lock-in gains, but it comes at the cost of reduced income. While there is not a magic bullet to preserve both gains and income simultaneously, gains can be harvested and reinvested in strategies that may help mitigate unrealized losses going forward. Potential approaches include:

  • Isolating credit spreads through floating rate investment-grade bonds and bank loans;
  • Reducing interest-rate beta via tax-exempt municipals and TIPS; and
  • Modifying accounting classifications—held-to-maturity versus available-for-sale

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