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Serving the Cause of Public Interest

Institute of Actuaries of India 26th Indian Fellowship Seminar. Interest Rates – Where are they headed?. Interest Rate Guarantees – How to Manage them?. Presenters: Navin Ghorawat Rakesh Kumar. 15 th December, 2016 Mumbai, India. Guide: Mr. Sachin Saxena. Indian Actuarial Profession.

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Serving the Cause of Public Interest

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  1. Institute of Actuaries of India 26th Indian Fellowship Seminar Interest Rates – Where are they headed? Interest Rate Guarantees – How to Manage them? Presenters: Navin Ghorawat Rakesh Kumar 15th December, 2016 Mumbai, India Guide: Mr. Sachin Saxena Indian Actuarial Profession Serving the Cause of Public Interest

  2. Agenda • Where are the Interest Rates Headed? • Historical Interest Rates – Range and Spread • Future of Interest Rates – Best Estimate and Alternatives • Impact of Demonetization • 2. Interest Rate Guarantees and How to Manage them? • Why and how guarantees arise? • Impact of Guarantees on different Products • Management of Interest Rate Guarantees • Case Study: Japanese Life Insurance Industry www.actuariesindia.org

  3. Historical Interest Rates - Range Historical 10 years G-Sec rates in India www.actuariesindia.org

  4. Historical Interest Rates - Spread Comparative 10 years Bond Yield (India, UK,US, Japan and Brazil) www.actuariesindia.org

  5. Future Interest Rates – Best Estimate www.actuariesindia.org Reasons for Interest Rates falling to 4.5-5.5% Modi Govt. View: Target Inflation of 4% and Target Real Yields of 1.25-2% RBI Stance: Change of Governor, Supporting Govt. view Weather (Monsoons): Good Monsoons have lowered CPI Fiscal Deficit and Govt. Budget – Higher tax revenues, Income Disclosure Scheme, Disinvestment Proceeds Sluggish Growth (as the IIP suggests) Stable Currency – India attracting capital flows as a safe haven

  6. Future Interest Rates - Alternative www.actuariesindia.org Reasons for Deviation from Best Estimate Weather: Bad Monsoons can have an adverse impact on Inflation and hence rates. Indian Govt.: Recent moves have not been as successful as hoped. Rajya Sabha minority still an issue. US/UK Quantitative Easing: If the developed economies raise rates and the spread between Indian and US/UK yields narrows, capital will flow out from India. Price of Crude Oil: Major drop in inflation and interest rates was due to sharp fall in Crude Oil prices. This trend has started to reverse. Global Political Environment: Syria, Brexit, Trump, Immigrants in Europe

  7. Impact of Demonetization • Accelerated Fall in Interest Rates due to increased money in banks. • Increased Transparency and Move to Financial Savings leading to greater exposure to debt and equity markets. • Reduction in Economic Activity: Negative Wealth Effect and decrease in currency in circulation. • Massive Fiscal Gains: Higher tax revenues to significantly reduce fiscal deficit • Undisclosed notes to reduce RBI liabilities and will be eventually available to be distributed as dividend to Govt. • Increase in Demand for Govt. Papers: Higher demand of Govt. bonds from Banking sector as deposits pick up. • RBI to be more accommodative: Dealing with uncertain times, some moves might be perfected by trial. E.g. 100% CRR requirement for additional deposits. www.actuariesindia.org

  8. Why interest rate guarantee arises? www.actuariesindia.org

  9. How interest rate guarantee arises? www.actuariesindia.org • How interest rate guarantee arises under life business

  10. Impact on Different Type of Products www.actuariesindia.org

  11. Management of Interest Rate Guarantees:Reasons and Strategy www.actuariesindia.org

  12. Management of Interest Rate Guarantee:Possible Actions, Implications and Challenges www.actuariesindia.org

  13. Management of Interest Rate Guarantee: Regulations and Professional Guidance www.actuariesindia.org

  14. Solvency II: Management of Interest rate guarantees www.actuariesindia.org

  15. A Case Study: Japanese Life Insurance Industry www.actuariesindia.org • The impact of sudden decrease in interest rate and stay at low level for longer period of time • Rapid decline in the interest rate in1980s, led to heavy sales of insurance product with high guarantees • Insures invest their assets stock market and shock in equity market leads to large loss • 8 out of 27 Japanese life insurance companies had defaulted from 1997 to 2008 due to “Negative Yield Spread” • Insurers lost the policyholders confidence and leads to large surrenders • Steps taken by Japanese LI companies after sharp decline of Interest rate: • Stop selling high-yield saving products • Reduce guarantee interest rate and commission of saving products • Increase the policy reserves • Purchase the longer term bonds to improve yields and reduce duration gap • Use of interest rate swaps to hedge the interest rate guarantee under annuity portfolio

  16. Summary • Interest rate guarantee management is mainly for Capital management , profitability and solvency • Management through proper product mix, matching of asset and liability and use of derivatives • Follow the Regulatory provisions and Profession guidance • Take lesson from the countries have already faced the burden of interest rate guarantees www.actuariesindia.org

  17. 26th Indian Fellowship Seminar THANK YOU! Contact us: nvghorawat@gmail.com rakesh.k@licindia.com www.actuariesindia.org

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