Notional loss for insurers, mixed blessing for PFs

Rising interest rates have meant a notional loss for life insurance companies, while it is a win-and-lose proposition for provident funds. Both, however, do not mark their other portfolio to market. So short-term fluctuations do not impact their long-term returns.

The notional loss for insurers follows their marking to market investments under unit-linked insurance plans.

The win for provident funds comes in the 100 basis point fall in the stipulated rate of assured return, while the decline in gilt mutual funds hurts them.

With the 100 point reduction in the assured rate of return and the rising interest rate scenario, the shortfall between the actual rate of return and the stipulated 8.5 per cent has declined for provident funds.

"Triple-A rated papers, which were quoting at 5.9 per cent in February-March, is today at 7 per cent. This means that the negative spread of 3.5 per cent has now been reduced to 1.5 per cent, taking into account the fall in the stipulated rate of return," said Amit Gopal, senior vice-president of India Life, a Bangalore-based company that manages the corpus of provident funds.

Reacting much before many in the financial sector, insurance companies had decreased their maturity profile in the expectation of rising interest rates.

Some insurers decided to go short on their exposure in the bond market, thereby risking an asset-liability mismatch. "We took a call on interest rates and decided not to hold paper of more than two-year duration. Today we are better off as we can invest at higher yields," said B Natraj, director & chief operating officer, AMP Sanmar Life Insurance Company.

Meanwhile, the net asset values (NAV) of all gilt funds have crashed between 50 and 250 basis points in the last two days alone following the announcement of the latest inflation numbers at 7.51 per cent.

As a result, almost all debt funds have reported value erosion, and those with a high exposure to gilts have suffered the largest falls. The NAVs of many unit-linked insurance plans have fallen by two to three per cent.

Four debt funds categories- debt hybrid, debt short terms, debt medium terms and floating rate funds- have posted positive returns on a one-week and a one-month horizon, but over a three-month horizon, they have posted absolute losses.

Since insurance companies do not need to mark-to-market their investments and usually hold their investments to maturity as they try to match liabilities with assets, they do not make any immediate loss unless there is redemption pressure on account of claims.

"Life insurance companies cannot punt on interest rates as for them it is a long-term contract, "said Deepak Satwalekar, managing director of HDFC Standard Life Insurance Company.

Likewise, provident funds do not have to mark-to-market their investments and hence are not affected by the falling bond prices.

"However, provident funds which invested in gilt funds have taken a bad hit, especially where their investments stem from the peak of the bull run," said Amit Gopal of India Life.