Most U.S. life insurers have a stable rating outlook, but their managers should be paying close attention to economic assumptions and reserving practices.[@@]

Analysts at Moody’s Investors Service, New York, present those conclusions in a review of credit trends in the U.S. life and health insurance market.

Although 73% of the 174 rated carriers ended 2004 with a stable financial strength rating, Moody’s assigned a negative outlook to 17% and was reviewing 4% for downgrades. The company had assigned a positive outlook to only 4% and was reviewing only 1% for possible upgrades.

Arthur Fliegelman, a Moody’s vice president, says he sees challenges ahead for life insurers that sell variable annuities with guaranteed living benefits and no-lapse universal life products.

It will be “a very tough challenge” for companies to balance the market’s demand for these features with risk management measures, Fliegelman says.

The Moody’s report gives special attention to the assumptions used to price no-lapse UL policies.

Life insurers must make assumptions about interest rates, policy persistency and mortality, and insurers may have problems with forecasting all 3 of those variables, Moody’s analysts write.

Many insurers seem to be assuming that interest rates will go up, but rates could stay low, and that could hurt the insurers’ earnings, the analysts write.

Assumptions that initial policy lapse rates will be in the low or mid single digits could be too low, and many of the purchasers are members of older age groups for whichh there is limited mortality data, the analysts write.

Elsewhere in the report, Moody’s analysts:

- Point out that the average financial rating for stock company insurers is “A1,” which is 2 notches below the “Aa2″ rating average for mutual insurers.

Stock companies have to answer shareholder questions about revenue growth, while mutual insurers may have more ability to respond to customers’ concerns, Fliegelman says.

“If you’re buying a life insurance contract, you are looking for stability,” Fliegelman says.

- Note that more strategic deals involve sales of blocks of business rather than sales of entire companies.

Sales of blocks “permit companies to improve their business position and profile in bite-sized chunks without the higher level of risk embedded in enterprise-wide acquisitions that require the integration and rationalization of an entire company,” the analysts write.