U.S. life insurers should emerge from the current financial turmoil largely unscathed, according to analysts at Moody’s Investors Service.
The life industry as a whole has a long-term insurance financial strength rating of A-1, and that reflects the industry’s stability, the analysts say.
The life industry outlook and rating incorporate the industry’s diversification, and “an expectation of continuing strong earnings, excellent capital adequacy, relatively modest financial leverage and healthy investment portfolios,” says Laura Bazer, a senior credit officer at Moody’s, New York, and an author of the report.
The life industry ended 2006 with an average risk-based capital ratio of over 400%, and market skittishness about lending should hold life insurers’ financial leverage down in the 20% to 25% range, Bazer and her colleagues write in their report.
The industry will feel some effects from the recent weakness in mortgage-backed securities and related asset classes, but “there will be more modest losses and more manageable losses compared with banks” mainly because insurers have put less of their portfolios in collateralized debt obligations, Bazer says.
The Moody’s analysts note that life insurers face risks related to volatility in the stock market as well as to problems with asset-backed securities.
Products linked to the performance of the stock market, such as individual variable life and annuity products and group pension products, have helped insurers increase sales, deposits and asset-management fees, the analysts write.
About 40% of the industry’s assets now support equity-based products, the analysts write.
Although equity-based products can be profitable, “these markets often exhibit intense competition and lack of pricing discipline, particularly products sold in the brokerage producer channel,” the analysts warn.
The more life industry products resemble mutual funds, the more volatile industry earnings will be, Bazer says.
When a life insurer is selling equity-based products, volume becomes more important, and the percentage of revenue coming from fees tends to be lower than with traditional life products, Bazer adds.
Moody’s analysts say other risks facing the life industry include an environment that might increase the difficulty of getting bank letters of credit; the possibility that further deterioration in economic conditions could hurt life insurers’ investment portfolios; and the possibility that weakness in asset-backed securities could squeeze the portfolios backing the money market fund operations that some insures’ asset-management arms run.
If a company-managed money market fund owns a significant amount of structured paper or asset-backed securities, and marking losses to market results in a fund’s net asset vale dropping below the $1 floor, an insurer may have to protect its reputation by using its cash to shore up the money market fund, Moody’s analysts write.