Life Insurance Companies Wary of Possible Deflation

By on December 21, 2010 at 7:28 am

In the current economic climate, there are some prognosticators who are concerned the nation may be on the cusp of entering a long-run deflationary period. Life insurance policies and the companies that administer them are particularly vulnerable to struggle in deflationary environments.

Insurers write policies using actuarial data which considers the life expectancies of the policy holders as well as assumptions of market rates of return in the future. Companies take the insurance premiums and invest them, earning a market rate. These returns on investment make up the majority of the profit of insurers.

In extreme deflation, market rates of return become miniscule as public companies struggle to stay in business and as government policy-makers drastically increase the money supply in order to stimulate economic growth. Flooding the nation with additional money drives down interest rates on bonds, a common investment for life insurance companies. As the interest rates decrease, insurers will see their profitability levels squeezed, perhaps even to the point where they are no longer able to earn enough on their investments to cover claim payouts to policy holders.

Japan is a frightening example for insurance companies. Japan is the largest modern economy to recently struggle through deflation. Interest rates on Japanese 10 year bonds fell from 8 percent in the 1990s to 1 percent recently as the Japanese government pumped money into the economy to forestall economic stagnation and the Japanese stock market has not yet recovered from its massive collapse.

Insurance companies in Japan have felt the effects. A 2005 report showed that the number of insurance companies operating in Japan was only half of what it had been only 10 years previously.

American companies are wary of the possibility of deflation in the U.S. While most experts agree the odds are low, the devastation of the possibility leaves insurers worried. Current inflation rates have slowed to their lowest points in many years and the general economic uncertainty are forcing life insurance companies to consider the ramifications of deflation and lower investment returns on their business operations.

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