With rates staying low, carriers have a dim three years on the horizon
Harder times for the U.S. life insurance industry, thanks in large part to the Federal Reserve, led Moody's Investors Service on Thursday to cut its outlook for the group to negative, from stable.
The carriers, already staggering under the weight of perpetually low interest rates, were dealt another blow that day when the Fed announced a third round of quantitative easing in an effort to boost job growth.
The central bank said it plans to snap up $40 billion of agency mortgage-backed securities every month and keep the federal funds rate at between zero and 0.25% at least through mid-2015.
That's terrible news for life insurance companies, which already have seen returns on their huge fixed-income investments dry up. The profitability of spread-based insurance businesses, including fixed annuities and universal life insurance, as well as long-dated business such as long-term care insurance, also have plummeted.
The next three years promise to be difficult ones for the insurers, who will take a hit to their capital and could be downgraded, according to Joel Levine, associate managing director at Moody's Investors Service.
“The industry will have a reckoning in terms of profitability deteriorating more rapidly,” he said. “Companies will be forced to revise their interest rate assumptions downward. Three years from now, with rates at this level or lower, it would pretty much force companies to recalibrate their reserves.”
On their own, near-zero rates don't pose an insolvency threat to companies over the period, but they could hurt ratings. “Could a company that's sensitive to interest rates see a 20% decline in its [risk-based capital] ratio? Yes, it makes them weaker and they might be downgraded,” Mr. Levine said. “That's what we're talking about as opposed to insolvency, which would take more serious conditions.”
In one sense, some insurers that sell universal life insurance with no-lapse guarantees are facing a one-two punch in the form of low rates and changing reserving requirements for those products. Such guarantees ensure that the policy stays in force even if the cash value falls to zero, as long as the client makes the minimum premium payments. Insurance regulators are concerned that some companies do not have adequate reserves to make good on these policies.
On Wednesday, the National Association of Insurance Commissioners' executive committee/plenary attempted to address the issue by passing revisions to Actuarial Guideline 38, which spells out how much insurers should reserve for those guarantees. That change may subject contracts issued after July 1, 2005, to higher reserve requirements.
“Some companies could have significant increases to their reserves and some might have minimal impact, if any,” Mr. Levine said.
The Moody's report said more frequent and larger write-downs on earnings are likely as it becomes more difficult for companies to contend with reserve calculations that were based on higher interest rates.
Meanwhile, legacy variable annuity blocks are contending with the double-whammy of the impact of low rates on contracts with living benefits and equity market volatility, which raises hedging costs for insurers.
“With higher-than-pre-crisis levels of volatility now likely to be a more persistent feature, we expect earnings and capital to be under greater pressure over the next 18 months,” according to the Moody's report.
To add insult to injury, the weak economy will continue to weaken insurers as consumers choose not to spend on their products, according to Moody's.
