A deteriorating economy and the prospect of a prolonged bear stock market spell further profit pressure for insurers.
The end result could be a shakeout of weaker companies, hence less competition and, ultimately, higher life insurance premiums for consumers.
Though the long-term fundamentals of the life insurance industry remain strong, sharply falling variable-product sales, shrinking asset-based fees and an inability to raise life premium rates are combining to erode insurers' operating profits, says Michael Albanese, a group vice president at rating agency A.M. Best Co. in Oldwick, N.J.
At the same time, falling rates and a recent steep decline in the quality of corporate debt are expected to cut returns on insurers' general-account assets, which many companies have used in recent years to bolster earnings.
This year's third quarter was the second-worst ever for junk bond defaults - 48 companies have defaulted on $21.9 billion in debt, according to Moody's Investors Service in New York. All told, corporations have defaulted on more than $76 billion this year.
"It's worth emphasizing that the factors driving the default rate higher were in place prior to the atrocities of Sept. 11," says David Hamilton, vice president and director of default research at Moody's.
Bad news
Mr. Hamilton has now raised his default forecast to 10% of the dollar volume of outstanding junk bond issues, up from 9.5%. He thinks defaults could rise to as high as 11% by March.
That's bad news for insurers who have sought to boost their returns by holding more junk bonds.
American International Group Inc. and Conseco Inc. both recently took $125 million write-downs on collateralized debt obligations and other high-yield investments. Conseco shares are trading near a 10-year low because of renewed worries over the company's solvency.
Regulators are stepping up their efforts to monitor liquidity risk. "One would have to be foolish not to have a heightened vigilance because of everything that is happening," says Larry Gorski, chief actuary with the Illinois Department of Insurance.
Those developments haven't gone unnoticed by jittery investors. Life insurance stocks have trailed the performance of the broader market for four weeks straight - a sharp reversal from the sector's strength earlier this year. Last week, the Morgan Stanley Life Insurance Index was 12.5% behind the Standard & Poor's 500 stock index.
The impact of the declining equity markets on companies' annuity operations is also coming under sharper focus as insurers report third-quarter results. Both Nationwide Financial Services Inc. and Lincoln National Corp. acknowledged steep drops in their annuity operating profits.
Earnings down
Nationwide's individual-annuity pretax earnings fell 23% to $54.2 million year over year on a 16% decline in fees from lower separate-account assets. Life insurance sales fell 31%.
Though Lincoln National beat analysts' consensus third-quarter earnings forecast, its stronger earnings came from life reinsurance. It is selling that business to Swiss Re. And despite generating positive annuity net sales for the first time in four years, annuity operating earnings fell 30% to $72.4 million.
A.M. Best's Mr. Albanese predicts that the fallout from declining interest rates and the depressed stock market will force a further weeding out of competitors.
"Many companies had been reliant on sales of investment-oriented contracts and fees to support their overall infrastructure. With those fees disappearing, it's going to be very difficult for them to differentiate themselves and grow their top and bottom lines," he says.
Several insurers are taking steps to bring expenses more in line with the weak market.
AXA Financial Inc., the former Equitable Cos. Inc. unit of French insurer AXA SA, last month laid off 500 employees, or 8% of its U.S. work force.
And while MetLife Inc. has announced $100 million in expense cuts for next year, including laying off up to 1,900 employees, analysts worry that the country's biggest life insurer isn't cutting deep enough.
