It was bad news that financial strength downgrades trumped upgrades by three to one in 2002, but the bad news isnt over, according to a Moodys Investors Service report, which says that downgrades again are likely to outpace upgrades in 2003.
In fact, Moodys has changed the near-term outlook for the whole U.S. life insurance industry to negative from stable.
New York-based Moodys cites factors including credit losses, declining equity markets and low interest rates as a few of the challenges the life insurance industry currently faces.
Offsetting these problems, according to the Moodys report, “Credit Issues and Trends for U.S. Life Insurance,” are “core strengths” that include “adequate capital supporting conservative balance sheets, predictable and profitable blocks of seasoned liabilities and tax-favored product offerings.”
Robert Riegel, managing director at Moodys, says the best scenario that would lead to the removal of the negative outlook would include an improvement in the economy, significantly lower corporate bond default rates and a slow rise in interest rates as well.
The interest rate increase, according to Riegel, could not be a spike because it would encourage disintermediation to bank CDs or new fixed annuity contracts.
The current interest rate environment is not good because of spread compression on the difference between rates guaranteed in contracts such as fixed annuities and rates currently available for investments, Riegel explains.
Expanding on the reports prediction that acquisitions of blocks of business will become more prevalent, Riegel says variable annuities are one product line in which players will experience consolidation.
VAs are a “low margin, commodity-like product, so it is critically important to have significant scale to make a go of it,” he adds. Advantages such as scale and distribution are important to success in this product line, Riegel says. In fact, he adds he has heard of companies that have decided to stop selling VAs and to sell their in-force business.
Market declines have made the VA business, particularly contracts with guarantees, more difficult to manage, the Moodys report notes. “Low frequency, high severity risk” associated with secondary guarantees, including guaranteed minimum income benefits, guaranteed minimum death benefits and guaranteed minimum accumulation benefits as well as “other risks that continue to appear” such as dollar-for-dollar partial withdrawals continue to be a concern of Moodys, the report says.