When Weiss Ratings recently calculated profits at the country’s largest life and annuity insurers had dropped a whopping 84 percent in 2011, it definitely caught our eye.
To grasp the reasons behind this dropand what it means for the industry as a wholeLifeHealthPro.com spoke with Gavin Magor, left, senior financial analyst at Jupiter, Fla.-based Weiss Ratings, an independent agency that rates U.S. insurance companies and financial institutions.
LHP: What’s behind the decline in profits?
Gavin Magor: Apart from the obvious movement toward reserves being increased, what we think is probably driving it, and it’s hard to be specific, is a movement away from affordable rates, meaning the affordability for the insurers to maintain the guaranteed rates to the annuity holders, given the lower yields that are achievable on investments at present.
Many of the larger insurers had guaranteed minimum rates of return on variable annuities that are higher than the companies can achieve. This clearly has affected the insurers that also have guaranteed minimum withdrawal or income benefits at a high level that is not currently achievable. It appears that there has been greater demand, and they have not been able to keep up with that.
LHP: Yet you say there is no risk of failure. Why?
Magor: At this stage, the life insurers as a broad group have been extensively well capitalized and have performed exceptionally well even through the financial crisis. From that perspective, this isn’t a threat to their financial viability. If it continued beyond this year, and they continued to increase reserves to the same extent they have had to, we would have to reassess the impact on the overall financial strength of the insurers. However, for the larger ones, they certainly have the capacity for that. It’s not desirable but they have the capacity for these losses. Yes, they’ve got to do something about it. But we have to see if the 2012 development of reserves stays the same and see what it does to their profitability. If it goes beyond 2012, there may be something that needs to be changed.
LHP: What can the insurers do?
Magor: It’s tough for them, because they are fairly constrained by what they might be able to do, apart from the obvious of bringing in the cash for payments, which isn’t really the issue for them. Cash flow isn’t the issue. It’s really to improve their yields and that means taking a page out of the property and casualty insurers’ book, which has essentially been a movement toward more low-rated bonds and investments generally. That carries some degree of risk, of course, but then gives you those high rates of return. There have been two schools of thought on it. There are those that are staying conservative and maintaining a very high-quality portfolio and those who are moving toward a more productive portfolio with greater risk. The question is whether being conservative is actually creating more risk. You are essentially going to be taking a known hit to your profitability and ultimately to your balance sheet in this particular case. Those that are investing in a slightly more diverse portfolio are perhaps not able to quantify their risks, but their yields are definitely higher. P&C insurers have definitely moved to a riskier investment portfolio. I know the two are not exactly comparable, but if they took a note from that playbook, then maybe the ultimate risk would be lower.
LHP: Several carriers have either exited or scaled back their variable annuity business. Why and what impact does that have on the industry?