Industry Surplus Fell Last Year For Only Time Since World War II
Financial strength records abounded in the life insurance industry in 2001. Some were good, some were bad, some were artificial in nature, and some were simply puzzling.
One hundred thirty companies, comprising 85% of life industry assets, experienced record capital losses and record shareholder dividend payments, which caused their total surplus to decline for the only time since World War II.
Data from the Townsend & Schupp Analyzer (an Internet financial analysis service) shows that the sum of surplus, asset valuation reserve (AVR) and interest maintenance reserve (IMR), fell 5.1% before accounting changes, but only 0.3% after accounting changes, in 2001. Surplus rose only 1.6% in 2000, which was the second lowest surplus gain post World War II.
The Good. Surplus paid-in of $12.2 billion in 2001 exceeded the previous high of $9.5 billion set in 2000. Also, the National Association of Insurance Commissioners codification of statutory accounting principles became effective Jan. 1, 2001, which increased total surplus for the 130 companies by $9.5 billion (4.8%).
The Bad. Shareholder dividends of $20.3 billion in 2001 nearly doubled the previous high of $10.8 billion paid in 1998. Net capital losses of $10.3 billion significantly exceeded the previous high of $7.2 billion set in 2000.
Total operating earnings fell 31% before taxes, and 27% after taxes. Ranked by aggregate earnings in 2000, pretax earnings fell
12% for individual life, 49% for group annuities, 67% for individual annuities, 20% for group life, and 100% for group health insurance, in 2001. Individual health earnings tripled from a modest base.
Declines in fixed annuity and life product earnings reflected lower interest rate margins, and a modest volume of World Trade Center death claims. Declines in variable annuity and life product earnings reflected a 6% decline in assets, and an 11% decline in fee income.
Return on equity of 6.4% in 2001 was the lowest return for the life industry in the last 25 years, under the previous low of 7.0% experienced in 1994 when interest rates fell sharply and health insurance underwriting losses mushroomed. Return on equity was in single digits for the 10th consecutive year.
The Artificial. As stated earlier, NAIC codification resulted in a non-recurring surplus increase of $9.5 billion.
The Puzzling. For the previous four years, 1997-2000, the aggregate Risk Based Capital (RBC) ratio for the 130 major companies hovered in a narrow range of 273% to 278%. But, in 2001, the RBC ratio jumped from 278% to 345% for the 130 companies, despite the fact that their aggregate surplus declined.
Asset risk factors in the RBC formula, which historically comprised two-thirds of total RBC required capital, were changed for most asset classes to include pretax and post-tax risk factors. This contributed heavily to the 24% gain in the RBC ratio for the T&S Composite of 130 companies.
Companies that experienced large asset losses on junk bonds, commercial mortgage loans, and collateralized mortgage obligations in the early 1990s, and that went into conservation, also lost investment income and reported operating losses, and were in no position to recover tax benefits on investment losses.
Does the jump in RBC ratio from 278% to 345% overstate the financial strength of the life insurance industry, from 2000 to 2001?
Composite Industry Results. Table 1 shows the components of surplus changes for 1997-2001 for the T&S Industry Composite. Surplus includes the AVR and IMR, while operating earnings exclude amortization of the IMR.
Table 2 shows that 50 of 118 stock companies (of 130 total companies) paid-in new surplus of $12.2 billion in 2001. These include the Hartford Life Companies at $2.7 billion paid-in; Principal Life, $1.6 billion; Swiss Re, $1.4 billion; Prudential Insurance Company, $1.1 billion; the MetLife Companies, $882 million; the AIG Life Companies, $850 million; the ING Life Companies, $771 million; and the AEGON Life Companies, $705 million.
Shareholder dividends paid-out exceeded new surplus paid-in for the eighth consecutive year, and the net payout of $8 billion in 2001 exceeded the previous high of $7.5 billion set in 1998.
Table 3 shows net investment yield on mean assets, return on mean equity, and capital ratio (total surplus to invested assets) for the T&S Composite for 1990-2001.
Net investment yield fell for the ninth time in 12 years, in 2001, and experienced its sharpest decline (32 basis points) since 1994 (49 basis points).
Return on equity set a 25-year low of 6.4% in 2001, and remained in single digits for the tenth consecutive year.
Capital ratio (total surplus to invested assets) fell to 10.8%, its lowest level in five years and second year of decline from an industry high of 11.9% at Dec. 31, 1999.
Declines in the capital ratio reflect a desire to improve returns on capital, by reducing capital committed to the life industry. In 2000 and 2001, 53 and 59 of the 130 life companies, respectively, reduced their total surplus.
Will the change in the RBC factors, which caused the T&S Composite RBC Ratio to jump from 278% to 345% in 2001, cause even more life companies to reduce their aggregate surplus in 2002, because their new RBC ratios are deemed higher than necessary?
Table 4 shows a historical record of surplus changes for the fourth quarter and calendar year, and the number of 130 companies that experienced specified operating results in calendar years 1993-2001.
Table 4 also shows that a record number of the 130 companies set one good record for 1993-2001, namely surplus paid-in. But, a record number of the 130 companies set nine-year highs for operating losses, capital losses, having both operating losses and capital losses, shareholder dividend payments, and surplus declines.
Table 5 shows death benefits incurred in each quarter of 2000 and 2001, because of the interest in the magnitude of the World Trade Center claims. While unexpected, the WTC disaster was a manageable risk for life insurers.
The table on page 51 shows components of surplus changes for each of the 130 life insurers in the T&S Database, comprising 85% of industry assets.
Eleven companies had operating earnings exceeding $500 million, and accounted for 61% of the composite earnings: (in order) New York Life, Metropolitan, Teachers, Monumental, Mass. Mutual, Principal, John Hancock, SunAmerica, Connecticut General, Travelers and Equitable (N.Y.).
Twenty-five of 130 companies had operating losses in 2001, and 16 companies had both operating losses and net capital losses.
Four companies had net capital gains exceeding $100 million: (in order) Metropolitan, Swiss Re, GE Capital Assurance, and ReliaStar.
Only 27 of 130 companies reported net capital gains in 2001. Of the 103 companies with net capital losses in 2001, 67 companies had earnings in excess of their capital losses.
Among the 118 stock companies, 50 companies had net surplus paid-in of $12.2 billion, while 71 companies paid shareholder dividends of $20.3 billion in 2001. Five former mutual companies accounted for 55% of the total shareholder dividends paid-out: (in order) Prudential, Metropolitan, Equitable, Principal and John Hancock.
In 2001, 59 (45%) of the 130 companies had surplus declines, on the heels of 53 companies in 2000. Over the last four years, the number of companies reducing their total surplus during the year has averaged 36%.
Excluding surplus paid-in and accounting changes, the largest percentage surplus gains were reported by Standard Insurance, 22%, Merrill Lynch, 18%, and AFLAC (where everything was ducky) 17%.
Largest aggregate surplus gains in 2001, exceeding $500 million each, were reported by Mass. Mutual and Northwestern Mutual (because of accounting changes) and by Met Insurance & Annuity and Hartford Life and Accident (because of surplus paid-in).
Frederick S. Townsend, a founder of The Townsend & Schupp Company, is an investment banker in Hartford, Conn.
Reproduced from National Underwriter Life & Health/Financial Services Edition, April 15, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.