Actuarial Assumptions and the Interest Rate Environment: Implications for Asian Life Insurers

The Rate Environment Has Changed. Have Your Assumptions?

For most of the decade preceding 2022, the operating assumption for Asian life insurers was a prolonged low-interest-rate environment. Investment portfolios were positioned accordingly. Products with guaranteed crediting rates continued to be sold. Reserving methodologies embedded discount rate assumptions consistent with the rate environment that existed. Actuarial teams and boards understood the risk in the abstract but managed under the assumption that rates would remain low for the foreseeable future.

The normalisation of rates since 2022 has changed the calculus materially. For some products and some balance sheets, the effect has been favourable: higher discount rates reduce the present value of long-duration liabilities, providing relief on the reserve side. For others, particularly where guaranteed crediting rates on legacy business are locked in and the investment portfolio is not positioned to benefit fully from the rate shift, the impact has been more complex.

The core challenge for actuarial functions and boards in Asian life insurers now is whether the assumption bases that underpin reserving, pricing and financial projection are calibrated for the current environment, not the one that existed when those assumptions were last set. This briefing examines the key areas where assumption review is most urgent and the governance process for managing assumption changes with boards and regulators.

Why Legacy Guaranteed Rate Products Remain Sensitive

A large portion of in-force life insurance business in Asia was written during the extended low-rate era and carries guaranteed minimum crediting rates or guaranteed returns at maturity that were calibrated to the investment environment of that period. For participating policies, whole-of-life products with guaranteed cash values and endowment products written in markets like Singapore, Malaysia and Hong Kong, these guarantees represent a contractual obligation to policyholders that does not dissolve with a change in the rate environment.

The practical challenge is that the investment portfolios backing these liabilities were also positioned for the low-rate environment. Portfolio yields on bonds and other fixed-income assets purchased when rates were low will persist through their duration. The yield on a portfolio is a weighted average of what was purchased when, and it adjusts slowly.

The combination of:

• Legacy guaranteed crediting rates that are fixed above current cost of funds in some books
• Investment portfolios that are still weighted toward assets purchased in the low-rate period
• Increasing policy lapses in some markets as policyholders assess the relative attractiveness of keeping versus surrendering

creates a dynamic that requires careful monitoring and, in many cases, assumption review.

The lapse risk dimension is particularly important. When market rates rise, policyholders with guaranteed products that compare unfavourably to current market returns have an economic incentive to surrender and reinvest. Lapse rate assumptions embedded in in-force reserves and capital models may not reflect the current competitive environment for savings products.

Discount Rate Assumptions and Long-Duration Liabilities

The impact of rising discount rates on the present value of long-duration liabilities is the more favourable side of the rate normalisation story for life insurers. Under most valuation frameworks in use across Asia Pacific, a higher discount rate reduces the present value of future liability cash flows, improving the reported solvency position.

However, the extent to which higher market rates translate into higher discount rates used in reserving depends on the specific valuation framework and the assumptions it incorporates.

Under the Singapore RBC2 framework, interest rate risk is captured through scenario-based testing that models both the liability and asset sides under stressed rate movements. An insurer with duration-matched assets and liabilities is insulated from the capital impact of rate moves in either direction. An insurer with a significant asset-liability duration mismatch is exposed: if liabilities are longer duration than assets, a rate increase reduces both sides but reduces the liability side more, improving the position; if assets are longer duration, the asset value falls more than the liability, worsening it.

Under IFRS 17, which Singapore-incorporated insurers applying international accounting standards now use, discount rates for insurance contract liabilities are based on observable market rates adjusted for the characteristics of the insurance liability. The quarterly or annual recalibration of these discount rates means that rate movements flow through to the liability measurement more directly and frequently than under older reserve frameworks.

Actuarial teams should confirm that their discount rate methodology is appropriately calibrated to the current rate environment and that the review and approval process for significant assumption changes is operating as designed.

Pricing Implications for New Business

The rate environment affects new business pricing in two directions.

For protection products, where the liability duration is driven by mortality and morbidity rather than interest rate guarantees, the investment return on backing assets is a component of the pricing basis. Higher investment yields on backing assets can support lower premium rates, all else equal, which is a positive development for competitiveness.

For savings and investment products with guaranteed rates, the pricing challenge is different. Products that offer competitive guaranteed returns need to be backed by assets that can earn at least those returns. In a higher-rate environment, guaranteed rates can be set higher than was viable during the low-rate era, but the spread between guaranteed rates and achievable investment returns must still be positive and sufficient to cover expenses and provide a margin.

Common pricing assumption errors in the current environment:

Using historical average investment return assumptions that embed the low-rate period rather than assumptions consistent with the current rate environment and expected future path.

Under-estimating lapse sensitivity in competitive savings products. If a product offers a guaranteed return that is below what comparable market instruments offer, lapse rates should reflect that competitive dynamic.

Inconsistency between pricing and reserving assumptions. Where pricing assumptions on interest rates or lapses differ materially from reserving assumptions, the financial consequences of actual experience should be monitored and explained.

Stress Testing Your Position

Boards and senior management in life insurers should be able to answer a clear question: what does a sustained period of rate volatility do to our financial position? This requires scenario analysis that goes beyond the regulatory minimum.

Key stress scenarios to consider:

Higher-for-longer: Rates remain elevated for longer than the base case. What happens to lapse rates on legacy guaranteed rate products? How does the reinvestment yield evolve as the portfolio turns over? Is there a crediting rate or premium relief action available if lapses accelerate?

Reversal: Rates decline from current levels back toward the low-rate period. How does the liability valuation change? What are the implications for new business pricing? Does the investment strategy need to adjust?

Curve steepening or flattening: Changes in the shape of the yield curve affect asset-liability matching differently from parallel shifts. A life insurer with assets and liabilities both in the medium and long duration range is affected differently by a steepening curve than a parallel shift of the same magnitude.

Credit stress overlaid on rate stress: If higher rates are accompanied by credit deterioration, as has historically been common in certain economic environments, the investment portfolio faces dual pressures. The interaction between interest rate risk and credit risk in the investment portfolio should be assessed.

Communicating Assumption Changes to Boards and Regulators

Assumption changes in life insurance are consequential. A change in the discount rate assumption, the lapse rate basis or the investment return basis can have a material impact on reported profits, distributable surplus and capital ratios. This means that assumption changes require careful governance and transparent communication.

With the board: Material assumption changes should be presented to the board or board risk committee in a way that explains the change clearly, quantifies its financial impact, and sets out the basis for the change. The communication should address both the near-term financial impact and the implications for ongoing product strategy and capital management.

With actuarial peers: The assumption review process should involve the appointed actuary or equivalent role in the relevant market, and the rationale for any significant departure from prior assumptions should be documented thoroughly. Where external actuarial review is required by regulation, it should be factored into the timeline.

With the regulator: For material assumption changes that affect regulatory capital ratios or reserving bases, proactive communication with MAS or the relevant regulator is advisable rather than waiting for the next regulatory submission. Regulators generally respond more constructively to proactive notification of significant assumption changes than to discovering them in a submission.

Documentation standards: The documentation supporting assumption reviews should be sufficient for a competent professional with no prior knowledge of the specific portfolio to understand the basis for the assumption, the range of alternative assumptions considered, the quantitative impact of the chosen assumption versus alternatives, and the proposed review trigger and frequency.

What Boards Should Be Asking

The interest rate environment has changed materially enough that standard board questions about the business should now include a specific focus on actuarial assumptions and their calibration.

Questions boards should be asking:

• When were our key actuarial assumptions last formally reviewed? Were they updated to reflect the current rate environment?
• What is our lapse rate assumption for guaranteed savings products, and how does it compare to experience since rates rose?
• What is the duration mismatch between our investment portfolio and our insurance liabilities, and what is the capital and earnings impact of rate movements in either direction?
• If rates fall back to the levels of five years ago, what happens to our reported financial position and our solvency ratio?
• Are our pricing actuaries and reserving actuaries using consistent interest rate assumptions, and where they differ, what explains the difference?

These are not technical actuarial questions. They are legitimate business and governance questions that an engaged board should be in a position to ask and receive clear answers to.

We assist life insurers across Asia Pacific with actuarial assumption reviews, interest rate sensitivity analysis, ORSA development incorporating rate scenarios and board-level risk presentations. If your organisation is working through the implications of the current rate environment on your in-force book or new business pricing, our actuarial team is available to discuss your specific circumstances.