ACC says low rates drive up cost of future claims

Wednesday 11th July 2012

Accident Compensation Corp says it is "plausible" that interest rates are going to stay lower over the long term, eroding the state-owned accident insurer's theoretical returns relative to the cost of future claims.

ACC's returns relative to future claims are benchmarked to government bonds, which are trading at near record-low yields as the world's major central banks keep their key interest rates near zero. New Zealand 10-year government bonds are yielding 3.45 percent, less than half the 8 percent rate in 1992. Respondents in a Reserve Bank survey last month said they expect the yield to rise to 4.1 percent by March next year.

"We certainly think real interest rates could be lower than has been usual in the last 20 years," ACC's general manager of actuarial and risk Herwig Raubal told BusinessDesk. "Lower long-term interest rates are a plausible scenario."

Low interest rates led to Wellington-based ACC doubling its actuarial losses to $3.35 billion from previous forecasts in the 11 months ended May 31, according to the government's financial statements. That took the Crown's overall ACC insurance liability to $31.23 billion, some 5.3 percent bigger than expected in the May budget.

"The change in market interest rates had a very big impact - the month of May in particular," Raubal said.

The yield on 10-year bonds dropped almost half a percentage point that month. It fell to a record-low 3.24 percent on June 5, lower than the 3.87 percent level plumbed in early 2009 when the global financial crisis was at its deepest, according to Reuters data.

While actuarial losses mount, Raubal said he doubts lower rates will "threaten the scheme's management" as the ACC's actual investments are broader than the assumed 100 percent holding of government debt.

"Government bond yields have driven the movement in the valuation, (but) they are not a direct reflection of our investment return expectations," Raubal said.

ACC differs from market participants in assessing interest rates in that its horizon is much longer, with future claims payments going out as far as 90 years, whereas the longest-dated tradeable government debt is 12 years.

Markets are pricing in 10 basis points of cuts to the OCR in the coming year, according to the Overnight Index Swap curve. Reserve Bank Governor Alan Bollard kept the benchmark rate at 2.5 percent last month, while pushing out the track for future hikes by trimming its forecast for the 90-day bank bill rate.

The central bank sees the rate unchanged at 2.7 percent until June 2013, before peaking at 3.4 percent in March 2015. It had previously expected the rate to rise in December this year.

BusinessDesk.co.nz

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