Continuing low interest rates have prompted life insurers to boost their statutory reserves, according to a new report.
Moody’s Investors Services arrives at this conclusion in a special comment, “Continued Low Interest Rates Have Driven U.S. Life Insurers’ Statutory Reserves Higher.” The report analyzes the publicly-filed annual statements of actuarial opinion of more than 50 insurance groups, including more than 200 individual companies. These documents record for each U.S. life insurer the results of asset adequacy (also known as cash flow) testing performed under a variety of different interest rate scenarios.
The rating agency reports a 57 percent increase in additional reserves, primarily related to the low interest rate environment, in 2012 versus 2011. These “additional reserves” due to asset adequacy testing are set up in addition to the statutory formulaic baseline reserves.
Additional reserves in 2012 were $10.1 billion, or 3.4 percent of industry capital vs. additional reserves in 2011 of $6.4 billion, or 2.3 percent of industry capital. Over 50 percent of the U.S. life insurance groups that Moody’s rates added reserves in 2011, 2012 or both, says Moody’s.
“Many life companies have increased reserves, due to inadequate investment returns combined with contractual guarantees based on too-high expected returns,” says Neil Strauss, a Moody’s vice president senior credit officer and an author of the report. “Although insurers’ asset-liability duration matching has provided an element of protection, there is minimal hedging for this continued low rate scenario in the industry; thus, the need to add reserves.”
Looking forward, Moody’s expects a lower amount of additional statutory reserves at year-end 2013 due to the rating agency’s expectation that 10-Year Treasury rates will move up to around 2.75 percent by year-end. Moody’s bases this on its baseline economic forecast of GDP growth in the one to two percent range, improving jobs picture, and future Fed tapering.
However, if rates plateau or decline from current levels, year-end 2014 is potentially a greater issue in terms of reserve strengthening, says Moody’s.
“Despite the recent rise in rates, ‘breaking out’ of a low rate environment could take a protracted period of time, as historical experience has shown,” Moody’s states, adding that the sluggish U.S. economy and recent government shutdown has “dampened the rise in interest rates.