Moody's: Life insurers more vulnerable to low interest rates than they think.

Moody’s feels that life insurers may be more optimistic than practical given that that accounting standards defer the recognition of low interest rates; their strong earnings projection under an adverse macroeconomic environment and their past underestimation of tail risks, namely, from long term care insurance and variable annuity with guaranteed benefits exposure.

In order to cope with new environment, life insurers have lowered their crediting rates in order to maintain interest margins, raised prices on new business and discontinued interest-sensitive products. Moody’s does not find these actions completely ameliorative however, and the rating agency augurs a widening gap between earned interest rates and interest rates implicit in pricing and assumptions. Moody’s sees a trend towards higher earnings charges and capital hits from spread compression.

Life insurers have been able to withstand the low interest rate environment fairly well but Moody’s warns that the longer rates stay low some of the products that life insurers offer can be adversely impacted. Namely, long term care will have to be re-priced (the increase will require regulatory approval), variable annuities with minimum income and withdrawal benefit riders will be re-priced or discontinued (higher reserves and hedging costs will also be impacted) and fixed annuities will be squeezed as companies hit contractual margins. Moody’s notes that life insurers’ “aggressive product management” has worked to mollify the impact that the low interest rate environment has had.

Moody’s warns that as companies’ investment portfolios earning the higher rates of former times are shrinking, and credit rates get closer to contractual minimum interest rates, profitability will be affected and writedowns could be required.