Sign of the times as insurers seek yield in riskier investments

Alternative investments, commercial mortgages, junk bonds all on the menu

By Darla Mercado

Aug 29, 2012 @ 11:52 am (Updated 4:22 pm) EST

Insurance
At The Hartford, a slight shift ((Photo: Bloomberg News))

Rock-bottom interest rates are driving life insurers to seek shelter in higher-yielding, riskier asset classes, a departure from their usual staple of corporate bonds.

Low interest rates took a toll on the performance of life insurers during the second quarter. At Genworth Financial Inc., the risk-based capital ratio of the carrier's U.S. life insurance unit fell 20 percentage points from the first quarter, to 405%, because of declines in equity markets and interest rates.

Meanwhile, at Hartford Financial Services Group Inc., finance chief Christopher Swift noted on a second-quarter earnings call that the company had extended the duration of its investment portfolio and “slightly increased” its holdings in higher-yielding asset classes.

Moody's Investors Service Inc. expects more insurers to ramp up their investments in these assets as they low rates continue to hobble them.

Private placements, commercial mortgage loans, high-yield bonds and bank loans are among the asset classes that life insurers are investing in to help boost their yields, Moody's noted in a research report.

“Some players continue to marginally lower their asset quality by stretching for yield and, on the margin, investing in more risky/less-liquid assets,” the firm's analysts wrote.

Aside from eating into investment returns from bond portfolios, low interest rates are generally bad news for product sales: Companies pare down fixed, indexed and variable annuities, as it becomes harder to provide guaranteed growth rates (or for indexed annuities, attractive caps). Likewise, long-term-care insurance depends on investment income and premium payments to help pay for claims.

In their hunt for yield, insurers aren't necessarily loading up on private placements and hedge funds, according to Ann Perry, vice president, senior credit officer at Moody's. “They're looking for incremental yield, so it's not a major allocation shift,” she added. “It's not something that in and of itself is going to be a ratings driver.”

Genworth spokesman Al Orendorff said that "alternative investments are capital intensive. We think it's best to remain in our conservative position."

Mutuals can afford to participate more in alternative asset classes, as they primarily offer whole life insurance and other products with a very long time horizon — and they can adjust dividends. “You need a period of time for these investments to work,” said Joel Levine, associate managing director at Moody's.

If interest rates remain at current levels, most insurers' earnings will grow at a low-single-digit rate this year, according to the ratings agency.

Though life insurers reported second-quarter net income of $7.5 billion, a 62% gain from the year-earlier period, much of that increase came from two carriers: MetLife Inc. reported net income of $2.3 billion, and Prudential Financial Inc. generated $2.2 billion in earnings.

Non-economic gains bolstered results at both companies. MetLife booked $1.4 billion in after-tax derivative net gains, mostly related to interest rate hedging. Prudential recorded a $1.5 billion gain from foreign currency-related changes.

Exclusive of the two giants, the industry's net income rose just 9%, according to Moody's.