A 5% decline in total statutory revenue for 2005 signals that U.S. life insurers are engaged in a delicate balancing act–how to energize the top line without jeopardizing statutory earnings and capital.
Fitch believes that much of the 2% decline in premium for 2005 can be attributed to a deliberate pullback by life insurers who have been assessing how developments in the regulatory and reinsurance arena will affect products and pricing. The industry is trying to figure out how to respond to growing demand for life and annuity products with long-term guarantees. These products are adding hard-to-quantify risks to the liability side of the balance sheet just as the industry has successfully reduced risk on the asset side.
Also contributing to the revenue decline in 2005 was flat investment income and declining investment yields, which have plagued the industry for the last five years. Fitch anticipates that the gradual rise in interest rates now under way will stop the slide in investment yields, although the impact in 2006 is likely to be minimal. Fee income associated with separate accounts increased 6%, although that is still a relatively small part of total revenue.
The total revenue number was also affected by a dramatic decline in reserve adjustments on reinsurance ceded. These adjustments, which are used in connection with modified coinsurance, are offset by an expense item and do not affect earnings. The decline in this revenue item reflects overall reduced levels of reinsurance ceded and higher retention rates.
Growth in total revenue was somewhat better among the largest life insurers. The top 25 life insurance groups–ranked by total admitted assets–experienced a 2% decline in total revenue compared with the industry’s 5%. Premium grew 2% for the large insurers vs a 2% decline for the industry. The most significant difference was in growth in investment income–5% for the top 25 life insurers compared with 2% for the industry.
A variety of factors drove results in the industry’s core segments. In the individual life segment, product development is in transition as companies respond to increased regulatory reserve requirements for term and universal life with secondary guarantees, uncertainty about the potential impact of “principles based” reserving, reduced and/or higher cost reinsurance capacity, and the need for products to comply with the 2001 Commissioners Standard Ordinary mortality tables.
Universal life was the only individual life product to experience sales growth in 2005, according to LIMRA’s year-end 2005 report, although the rate of growth declined to 10% from about 24% in 2004. Overall sales growth in the individual life line was up just 2% for the year, reflecting declines in whole life, term and variable life sales. Growth was concentrated among the leading writers, according to LIMRA.
Individual annuity sales declined 3% in 2005 compared with a 3% increase in 2004 (Kehrer/LIMRA). Annuity trends over the past few years have been driven to a large extent by equity-indexed annuity (EIA) sales, which grew more than 80% in 2004 compared with total fixed annuity growth of 14% (Beacon). Sales growth slowed starting in 2005 as the industry assessed potential regulatory changes affecting the EIA product. Variable annuity sales were up just 2% year over year. The financial markets have a significant impact on annuity sales, which vary with changes in interest rates and equity markets. Insurers who do not have a flexible product suite can get left behind.
Group annuity reserves were relatively flat, reflecting trends in stable value products. An 8% decline in group accident and health premium is attributed to the trend toward more voluntary coverage and the large corporate market’s increased willingness to self-insure.
The individual annuity line was the only core segment to post an increase in after-tax operating gain. Reduced crediting rates were the primary driver of the 4% increase. The individual life segment’s earnings declined 24% despite favorable mortality and reduced policyholder dividends. Increased reserve requirements related to level term and universal life products is the culprit. Earnings in the group annuity line were down 10% due to tighter margins for stable value products. Lower premium levels contributed to a 12% decline in earnings in the group accident and health line despite an improved combined ratio. Declines in core segments were offset by an improvement in the “other” line, resulting in flat overall earnings. “Other” is hard to identify and varies from company to company.
The industry overall has done a good job of bringing down expense ratios. This ratio, which excludes commissions, includes items such as salaries and wages for full-time employees, rent, travel expenses and other overhead items. The declining trend in the ratio is due to the fact that many companies have reduced full-time staff, streamlined legal entities and consolidated back-office operations. Companies have also disposed of non-core, unprofitable businesses.
Balance sheet and capital strength
Fitch views the life insurance industry’s capital position as strong, especially given the increase in shareholder dividends paid out and no significant capital paid in. In 2005, stockholder dividends exceeded policyholder dividends for the first time, reflecting the continued decline in the amount of participating life insurance. Fitch estimates that the industry’s risk-based capital ratio improved to over 400% from 382% in 2004, although the absolute amount of capital was relatively flat. Reduced exposure–and capital charges–related to credit risk in the investment portfolio was a contributing factor.
Fitch views the credit quality of the industry’s invested assets as good and at a five-year high with low defaults and delinquency levels. Below-investment grade bonds continued to decline as a percentage of total adjusted capital. Realized and unrealized capital gains also strengthened in 2005.
Industry outlook: It’s all about the pricing
Fitch expects top-line growth to pick up somewhat in 2007 as regulatory and reinsurance issues evolve and insurers move to comply with the 2001 CSO mortality tables. The industry has a significant role to play in meeting the growing demand for protection, asset accumulation and payout products. The key, however, is to sell the products profitably, and that is a function of pricing. Any risk can be profitable to insure if it is adequately priced for. Fitch believes that insurers who have the expertise to assess and adequately price for the risks–and then sell the products–will succeed. This is no small feat given competitive pressures and the complexity of some of the most popular products. Large, diversified insurers with economies of scale and significant financial flexibility will have a pricing advantage.