The Treasury yield curve inverted last weekend and many are worried: Sustainable inverted yield curves are often hit by recession. Insurers can also feel the effect, because the yield curve can affect the insurer's interest rates, profits and portfolio structure.
An inverted yield curve may be worrying. According to the Federal Reserve Bank of San Francisco, an inverted yield curve has preceded all nine US recessions since 1
An inverted yield curve is not the perfect prediction for future recessions. It has been a false positive at the end of 1966, where an inverted yield curve was followed by an economic slowdown, not a recession. There have also been several "flakes" of the curve, which did not lead to a recession.
But what makes last week's change in the 1-year reserve curve worried is the convergence of other negative signals over the past year – including expected macroeconomic considerations such as the abolition of the 2017 tax reform.
How can insurance be affected by a sustainable inverted yield curve?
An inverted yield curve has several consequences for insurance, some of which depend on the nature of an insurance company's liabilities and investment profile.
Lower long-term rates damage insurers whose claims take a long time to settle, such as work compensation. The money earmarked to settle these receivables is invested in long-term securities. When these rates fall, insurers insure less investment income, which lowers profits. This puts pressure on insurers to raise interest rates to compensate for the lost investment income.
The inverted yield curve also has consequences for insurance investments. In view of investments in interest-bearing real estate and real estate, an inverted yield curve will require adjustments to avoid inequalities in liabilities and income. Remedial measures may include the sale of assets to realize capital gains as the asset value of the bonds that had been bought at higher interest rates would now be more valuable.
Yield curve: a short primer
"Yield curve" Is a relationship between 10-year government bond yields and three-month bond yields. Usually, the 10-year bonds have a higher return than three-month bonds to compensate investors for long-term risks.
But when there is recession risk and fear of falling interest rates, investors invest in long-term bonds to "lock in" on returns that are currently higher than they think will be in the future. This increased demand for long-term bonds will, paradoxically, lower  returns because bond prices and interest rates are inversely related. At the same time, short-term bond requirements go down (since all run to long-term bonds), which increases returns.
If this happens, the three-month bonds will have lower interest rates than the 10-year bonds. And voila: the "normal" yield curve inverts.
The longer the inversion lasts, the higher the odds for a recession in the following quarter. For example, according to the Federal Reserve Bank of Cleveland, the yield curve was inverted in August 2006 before the start of the major recession in December 2007.