WASHINGTON — The ability of life insurance companies to pay their creditors during a period of ultra-low interest rates was significantly strengthened by a recent change in New York state insurance law, according to a new report by Fitch Ratings.
The rule restricts dividends that can be paid to a life insurer’s parent company so that it doesn’t impair the ability of the life insurance operating subsidiaries to pay claims.
The primary beneficiaries of the change were the nation’s 14 largest, publicly held life insurance companies, according to Fitch. The ability of the entire U.S. life industry to upstream dividends from the operating subsidiaries to the holding company did decline somewhat, Fitch said.
However, “Notwithstanding the decline in capacity, Fitch considers the absolute level to be strong.”
Specifically, the report said, “capacity remains fundamentally strong and adequate relative to holding company debt service requirements.”
The continued solid level of capacity in 2016 is supported primarily by profits generated by the underlying life insurance companies.
This was unlike 2015, “when there was more balance between statutory earnings and capital support for dividend capacity” profits generated at the holding company level.
The issue is significant because the Federal Reserve is in the process of crafting rules for the insurance companies it regulates. One of the issues it is dealing with is whether the Fed should evaluate insurance company financial health based on “consolidated” results, that is, earnings at both the operating level and the holding company level.
The reason? The Fed is concerned with how insurance company financial health affects the entire U.S. financial services industry. State regulators’ primary concern is consumer protection, that is, the ability of an insurer to pay its claims to customers, not its obligations to creditors, for example, bond holders.
Fitch explained that, in a typical insurance holding company structure in the U.S., relatively modest operating income is generated by the holding company itself, often in the form of income from investments held at the holding company.
“As a result, the majority of the holding company’s financial obligations are funded by income generated by its various downstream operating companies that is upstreamed via dividend payments,” the analysts said.
To the extent that this dividend income is materially reduced or non-existent, Fitch said, “the holding company’s ability to fund its operations and pay its financial obligations is at risk.”
The change in New York, which is effective in January, revised the capital rule to allow life insurance companies to upstream profits from their subsidiaries from the “lesser of” statutory net gain from operations or 10 percent of statutory surplus standard, to the “greater of” standard.
This change in regulation boosted overall industry capacity to upstream dividends by approximately $3.9 billion in 2016, Fitch said, and “significantly supported” overall industry capacity.
Fitch said its analysis of U.S. stock life insurers, statutory ordinary dividend capacity declined by 3 percent in 2016 to approximately $23.3 billion after remaining stable in 2015.
Without the change in New York rules, analysts said, the decline would have been greater.