Pension funds and insurers may
become insolvent if interest rates continue at current lows, the International
Monetary Fund (IMF) has warned.
In its latest global financial
stability report, the IMF discussed the challenges facing pension funds and life
insurance companies given the current low-rate environment.
“Sustained low interest rates
are eroding the viability of business models for many life insurance companies
and pension funds, threatening solvency over the medium term,” the report
For pension funds in most
countries, low interest rates mean higher liabilities, as lower discount rates
increase the present value of future obligations. Many pensions already face
funding gaps, and these have been “exacerbated” by low rates, the IMF said.
“Defined benefit pensions of US
and European companies have seen their funding gaps worsen since the onset of
the crisis,” the IMF said. “This reflects a combination of low asset returns
(especially on safe assets, such as sovereign bonds) and falling interest
Furthermore, the IMF said that
the shift toward liability-driven investing strategies, which rely on fixed
income products, will contribute to declining yields on those assets. This will
in turn reinforce funding gaps and generate additional demand for bonds in a
“potentially negative spiral,” the report warned.
A period of prolonged low rates
could also have disastrous effects on insurance companies. In the US and the
UK, the IMF said low rates are “straining their ability to control longevity
risk because of the higher cost of hedging.”
Meanwhile, insurance companies
in Germany and Japan, which often offer guaranteed returns, are at risk of “an
eroded asset-liability management gap as policies continue to pay out a return
higher than current rates.”
To address these risks, the IMF
said the International Association of Insurance Supervisors should “act
promptly to ensure the ongoing strength of insurance company balance sheets.”
In particular, the IMF highlighted a need for “high and robust standards” on
insurance capital—but warned that chances for consensus on an international
standard have been threatened by Brexit and the disinclination of the US Federal
Reserve to adopt such a standard.
As for pension funds, the
report suggested stronger regulations in Europe to ensure a common framework
for risk assessment and enhanced transparency, including valuing assets and
liabilities on a market-consistent basis to facilitate standardized reporting
and analysis. However, similar proposals have proven unpopular with European funds.
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