Strong asset valuations, an expected gradual rise in interest rates and continuing economic gains will underpin a stable outlook for U.S. life insurers in 2015, according to new report from Moody’s Investors Service.
A November brief from the credit rating agency forecasts that an improving macroeconomic environment will help fuel increases in the insurers’ revenues and earnings for over the next 12 to 18 months.
“With few significant threats to the U.S. economy, we believe there is little to impede life insurers’ ongoing financial improvement in the coming quarters,” the report states. Contributing to Moody’s stable outlook are these factors:
A continuing strong equity market that supports the health of legacy variable annuity (VA) blocks and fee-based income
U.S. equity market levels ranging from 15 percent to 30-plus percent above pre-financial crisis levels will boost the performance of legacy VA blocks, reducing a primary drag on the industry’s earnings recovery. AUM-driven fee businesses (e.g., pensions, mutual funds, institutional asset management business) will also continue to see improving profits.
The report cautions, however, that “a prolonged market correction” that reverses VA gains, or a continuation of depressed interest rates, could prompt Moody’s to change its outlook to negative.
Product redesign and re-pricing that improves the risk/profit profile of new business
Such improvements may encompass VAs features like volatility control funds that shift equity and hedging risks to policyholders; or “no-lapse” universal life (UL) insurance products that continue to be re-priced for lower interest rates.
“Strong pricing and product discipline will improve the industry’s liability profile as new sales replace maturing business over time,” the report states.
Rising interest rates in 2015 and beyond that gradually improve interest-sensitive earnings
Moody’s expects that monetary tightening by the Federal Reserve next year will boost interest rates, thereby easing spread compression on products like fixed annuities and universal life solutions. Higher rates will also reduce earnings pressure on certain long-term care products, while halting and/or reversing the slow decline in net investment yields.
The strong equity market and an improving U.S. employment outlook will “create incremental wealth” for U.S. households. Discretionary life insurance purchases, Moody’s believes, will increase demand for life insurance and annuity products. Wealth gains will also be reflected in higher contributions to 401(k) and other pension plans.
In tandem with higher earnings, consumers will also allocate more of their money to new fixed products, including fixed annuities. Individuals will also put more into their pension plans, increasing assets and fees for insurers.
On 10 November, the S&P 500 Index hit a record 2038.26, surpassing the previous 2000-plus record set in September. Continuing market gains over the last five years, Moody’s states, have contributed to life insurers’ earnings recovery, notably via their equity-sensitive and fee-based businesses. The gains contrast, however, with a “gradual decline of spread-based earnings” in the current low interest rate environment.