The Impact of Rate Increases on Independent Insurance Agencies

As posted on Big I.

The Federal Reserve raised interest rates by 25 basis points in March. Future increases are expected during each of its upcoming policy meetings through to next year.

Interest rates are being raised in an effort to control inflation. However, what does this mean for independent insurance agency owners planning strategic growth that requires financing?

The federal funds rate is the interest rate banks charge each other for overnight loans. The Federal Open Market Committee determines the federal funds rate. Interest rate hikes increase banks' cost of funds, which banks pass along to their customers.

Given the current market dynamics, continued interest rate increases are anticipated. Economic pundits are all making their predictions on how much and how many times rates will be raised. Without a doubt, the discussion and predictions make investors and business owners nervous.

Let's put context around the conversations. Yes, given the current economic climate and level of inflation, the Fed is in a position to use a critical tool—interest rate increases—to pump the brakes on inflation. It's a lever it has used successfully in the past. In the 1980s, the Fed's funds rate reached a high of 20% to combat double-digit inflation. Decades later, the Fed twice lowered the rate to a range of 0% to .25%. The first time was during the financial crisis of 2008. After that, the Fed didn't resume raising rates until December 2015.

The current interest rate conversations have been ongoing for several months. Further, the Russia-Ukraine war added a layer of complexity to the strategic discussions and decisions.

“The near-term effects on the U.S. economy of the invasion of Ukraine, the ongoing war, the sanctions, and of events to come, remain highly uncertain," said Jerome Powell, Chair of the Federal Reserve, in a meeting with the U.S. House Committee on Financial Services in March. “Given the current situation, we need to move carefully."

What does the rate increases mean for business owners? Well, to add context, let's start with defining the term “basis point." It represents the smallest unit of measurement for interest rates and other financial instruments. One basis point is equal to one-hundredth of a percent, or 0.01%, which means 100 basis points is equal to 1%.

In March, the Fed increased the interest rate by 25 basis points, which means rates are 0.25% percentage points higher. Prior to the increase, interest rates were at historic lows. Chairman Powell has said the Fed will be “humble and nimble" in navigating the situation and risks using data while communicating transparently. Raising the Fed funds rate by 25 basis points means a shift from 25 basis points to 50 basis points, making the U.S. prime rate of 3.25% rise to 3.5%.

To put that into perspective, apply the increase to a 10-year loan of $250,000. At a rate of 3.25%, a monthly payment is now $2,339.73 compared to $2,356.75—an increase of $17.02.

Many clients chose to review their balance sheets and refinance loans last year to take advantage of low rates. This year, owners who have long-term growth plans should not stop acquisitions and expansions. Review the decades of history related to interest rates. Since the 1980s, rates historically decreased and have been favorable for the business sector. The economic climate continues to be robust and healthy. In fact, the recent interest rate increase that brought us to a U.S. prime rate of 3.25% is where we stood pre-pandemic in March 2020.

Here are four takeaways for agency owners planning on financing:

1) Owners should continue moving business strategies forward. The best way to keep pace with inflation is to invest in good businesses that have the ability to raise prices without losing business to a competitor. The economy remains robust with low unemployment. Discuss opportunities with your lending partner. Navigate decisions based on thoughtful long-term forecasts. Take advantage of this historic low interest rate environment.

2) Weigh the options of a variable or fixed-rate loan. A short-term loan should not be as worrisome as considering a long-term loan deal. Remember, refinancing in the future is always an option.

3) Match your liabilities with your assets. Generally, long-term assets should be financed with long-term liabilities. Short-term assets should be financed with short-term liabilities. Weigh your ability to absorb future interest rate increases and your ability to pass along price increases.

4) Take market dynamics into account. Talk with lenders about your business and assess market dynamics to contemplate how it could be impacted by the overall market, not just rate increases. For example, our team works with travel insurance companies. It's been a hard business over the past two years. Decisions related to financing are very different for these customers than traditional insurance agents who cover auto, home, renters and other lines.

A global pandemic, supply chain challenges, the Great Resignation and the Russia-Ukraine war are not in our control. Use the recommendations above to control what you can to continue strategic and performance-driven business expansion and growth.

Rick Dennen is the founder, president & CEO of Indianapolis-based Oak Street Funding, a First Financial Bank company with customized loan products and services for specialty lines of business including certified public accountants, registered investment advisors and insurance agents nationwide.

About Oak Street Funding
Indianapolis-based Oak Street Funding, a First Financial Bank company, provides customized financial solutions for businesses in various industry sectors and third-party loan servicing for financial institutions. Oak Street Funding incorporates industry knowledge, easy-to-use technology and exceptional employees to deliver top-quality service and capital products to niche businesses nationwide. With in-house sales, underwriting, and servicing teams, and direct access to the CEO and executive team, Oak Street Funding is well-positioned to meet lending needs of borrowers in all stages of the business life cycle.

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