Insurers pivot amid declining interest rates

American Equity, American Financial Group, Lincoln National and Principal say lower interest rates are leading to reduced annuity payouts and, in some cases, lower sales.

Interest rates have done an about-face, and insurers are feeling the pinch.

Just less than a year ago, insurance companies, financial advisers and their clients were celebrating the return of higher interest rates. More money flowed into insurers’ coffers, which translated into better payouts on annuity and other insurance products.

The picture is much different these days, with the Federal Reserve cutting interest rates in July for the first time since the financial crisis and 10-year Treasuries plumbing fresh lows.

Insurers have had to pivot, taking measures that include diluting product features.

“It’s been quite a roller-coaster ride if you think about where we were at, where we went to and where we’ve returned,” Dan Houston, chairman, president and CEO of Principal Financial Group Inc., told analysts during the company’s second-quarter earnings call July 26.

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Lower interest rates mean insurers make less money on the investment portfolios, largely fixed-income holdings, that underpin their insurance products, causing a reduction in profits.

The 10-year Treasury yield has been cut in half from its recent high of 3.24% in November to 1.59% Wednesday. As bonds that insurers bought years ago mature, companies are having to replace them with lower-yielding fixed-income securities.

“Virtually all the carriers have said they’ll have to make adjustments to pricing,” said Scott Stolz, senior vice president of private client group investment products and wealth solutions at Raymond James & Associates Inc. “As their portfolio yield continues to fall, they’ll have to make adjustments to the pricing of pretty much everything they’ve got.”

Executives from insurers including American Equity Investment Life Holding Co., American Financial Group Inc., Lincoln National Corp. and Principal addressed the lackluster interest-rate environment in their second-quarter earnings calls.

American Equity, among the largest providers of indexed annuities, has reduced participation rates and interest-rate caps on some S&P 500 products three times since mid-April, said president Ronald Grensteiner.

For example, participation rates on its AssetShield 10 and Choice 10 indexed annuities bought with a market value adjustment rider have decreased to 40% from 54%. (A consumer would receive 40%, instead of 54%, of the S&P 500’s return over a given period.)

In addition, effective Aug. 6, the company decreased payouts on lifetime income benefit riders available on its annuities, Mr. Grensteiner said. Those will reduce guaranteed income on its best-selling IncomeShield products by roughly 6.5% to 7%, he said.

Other insurers have taken similar actions in response to interest-rate moves, with some hinting the changes could adversely affect annuity sales.

Craig Lindner, co-CEO of American Financial Group, said the company has made five or six adjustments so far this year and is “preparing to make another change as it relates to new business.”

Lincoln has reduced its crediting rates on fixed annuities and also dropped the guaranteed income rate in its variable-annuity living benefit riders by 0.15%, said Dennis Glass, Lincoln’s president and CEO.

“We’ve taken what we think are the necessary actions,” Mr. Glass said. “We’ll continue to do what needs to be done to get the proper return on new business.”

The Federal Reserve cut its benchmark fed funds rate by 25 basis points, to 2.25%, at the end of July, in an attempt to shore up the economy as the trade war between the U.S. and China continues and signs emerge of economic trouble on the international stage.

Economists expect the Fed will trim rates further by year-end, with some firms such as Morgan Stanley anticipating an eventual return to the rock-bottom rates that prevailed during the financial crisis.

The rate reduction was a turnabout from the Fed’s moves to increase interest rates in recent years in response to indicators such as low unemployment that were signaling a healthy economy. The Fed had raised rates nine times since the end of 2015, including four times last year.

Deanna Strable, CFO at Principal, acknowledged that there’s been a “slowdown” in fixed annuity sales as interest rates have declined.

“In the end, it just depends on, is the consumer willing to take the rates that we can afford to pay given everybody is kind of in the same boat,” said Mr. Grensteiner of American Equity. “And are they going to choose to not do anything and put it under the mattress or buy a CD or what, we don’t know.”