On Eve of First Quarter Results, Insurers Face Challenges

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As life insurers get ready to announce first quarter results, industry analysts say that as a whole the sector continues to face challenges.

Credit losses, the impact of low interest rates and heightened competition are among the problems that continue to hound carriers, they add.

Fitch Ratings, in a just-released report, cites the effect of spread compression in a low interest rate environment on fixed products along with fee pressure on variable products as a “double whammy” on insurance company earnings.

Spread compression could be alleviated to some degree by a new model law of the National Association of Insurance Commissioners that reduces minimum guarantees on fixed products to 1.5% from 3%, the report suggests.

However, Fitch continues, the degree of relief depends on whether state legislatures, enact the model. For the time being, the report adds, state-mandated minimum guarantees are contributing to spread compression. Although, this does not pose an immediate solvency issue for life insurers, it weakens the ability to grow earnings and capital in the current environment of low interest rates, poor credit markets and volatile equity markets, the report says.

Those factors, described in a year-end 2002 report issued by Fitch, will continue to affect life insurers, says Julie Burke, managing director with Fitch in Chicago.

For instance, on the issue of credit quality, some insurers have taken steps to recognize asset impairment, but other companies have yet to do so, she says.

Moodys Investors Service, New York, is maintaining a position enunciated at the beginning of the year that the life insurance industry faces significant hurdles in the current economic environment, says Robert Riegel, a managing director with Moodys life and health insurance group.

Default rates on corporate bonds, which impact insurers portfolios, remain at high levels compared with the 1990s, Riegel says. However, he does add that they seem to have reached their highest point in the second half of 2002 and have stabilized somewhat.

Some companies have reacted to the compression between the rates they pay out for fixed annuities and what they can earn on investments by pulling fixed annuities off of the market, he says.

But companies are really being affected by in-force business with higher rate guarantees, Riegel continues.

If a minimum guarantee rate is 3%, then companies need to earn a 4.5-5% spread, he says.

Initial indications for the first quarter, according to Riegel, are that there are no major negative surprises regarding life insurers recognition of losses.

Market conditions have caused the Fox Pitt Kelton index to be down 4% in first quarter 2003 compared with a 3.2% decline in the S&P 500 Stock Index, according to Bart Zanelli, senior vice president–corporate finance with Fox Pitt Kelton Inc., N.Y. In the first quarter, the S&P declined by 3.2%.

“Sins of the past” such as issuing annuity contracts with guaranteed minimum death benefits are among the reasons that stocks in the index have suffered, he adds.

Going forward in 2003, however, Zanelli says companies with a health bent are looking better. More generally, he continues, traditional insurers are cutting back on business that is not profitable. “A little bit more discipline is being brought into the market,” he continues. That is because management is becoming more aware that there needs to be more disciplined underwriting in order to achieve profitability, Zanelli explains.

And, although there might still be some company specific problems, a lot of insurers are taking steps to recognize impairment of their investment portfolios, he adds.

In a report earlier this year, Fox Pitt Kelton said that given equity market volatility and credit quality issues, traditional insurers selling traditional insurance products may be the best performers during 2003.

Earnings per share for the industry will grow at roughly 7% in 2003 and return on equity, 12.3%, according to FPK.

If there is a 10% decline in equity markets in 2003, then FPK is predicting that there will be a 3-8% earnings decline for life companies it lists. That decline will be due to DAC writedowns, credit quality issues and overall market conditions, the report states.

The report listed 10 industry fundamentals, citing two as positive, two neutral, and six, negative. Positive trends included life insurance persistency with a “stable” 8% lapse rate, and mortality rates.

Neutrals are life insurance growth rates in the “low single digits,” as well as accident and health loss trends.

Among the negatives cited by the report are annuity sales growth and persistency and investment yields and spreads.

In 2003, according to FPK, a 5% increase for variable annuity sales and a 10% decline in fixed annuity sales is forecast.

A report issued by Smith Barney, New York, predicted a total increase in annuity sales of 8% to $248 billion, with VA sales growing 10% to $127 billion and fixed annuity sales rising 5% to $121 billion.

The report, issued in January, also suggested that in 2003, average earnings growth rates would be in the 7-9% range with ROEs stagnant at between 11% and 13%.

But, a report issued by Smith Barney on April 15, offers some good news in terms of the investment quality for North American life insurers.

The report found that at year-end 2002, 78% of general account investments in the Smith Barney list of life insurers covered were fixed income securities.

Offsetting that finding, was a “foreboding” statistic that gross unrealized bond losses as a percentage of total equity averaged 11.6% at year-end 2002, the report said.

The reason, it continued, is because the downward interest rate environment suggests that they are credit related and “it is very likely that some portion of these losses will become realized over the next 12-24 months, thereby retarding book value and earnings growth, and likely along with this, stock price appreciation potential.”


Reproduced from National Underwriter Edition, April 28, 2003. Copyright 2003 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.