Outlook for life insurers is ‘credit negative' thru mid-2018

Continuing low interest will put a damper on life insurers’ investment yields and guaranteed rates of return in 2017, depressing their earnings, solvency position and credit outlook, which dipped from “stable” to negative during the year past.

The carriers’ credit and investment outlook may not improve until at least the second half of 2018.

So reports Moody’s Investors Service in its “2017 Global Life Insurance Outlook” report. The study examines the effect of macroeconomic and business factors on insurers’ balance sheets, including continuing low interest rates, market volatility and legislative changes.

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A negative credit outlook for life insurers prevails in the United States, which has $2.5 billion in policy premiums in-force (22 percent of the global total). The other top four countries (as measured by life insurance premiums) facing a negative outlook include:

• Japan (14 percent of global premiums).

• The United Kingdom (8 percent).

• China (8 percent).

• Germany (4 percent).

Despite a post-U.S. election bump in returns, low interest rates will continue to depress investment returns and net profitability, the report reveals. Yields on 10-year U.S. Treasuries have steadily dipped (except from 2012 to 2014) from nearly 5 percent in 2005 to less than 2 percent in 2016. Since 2012, 10-year moving averages of 10-year U.S. Treasury rates have also declined from just over 3.5 percent to less than 3 percent currently.

Moody’s foresees no improvement in investment returns, despite expectations for marginally higher interest rates in the short-term.

“Insurers will continue to reinvest maturing assets and invest new money at lower yields than current portfolio yields, even where rates will moderately increase, leading to continuous decline in investment returns,” the report states.

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Low interest rates are “credit negative” for insurance companies worldwide, the report adds, though interest rate risk varies by country. (Photo: Thinkstock)

Interest rate risk by country

Low interest rates are “credit negative” for insurance companies worldwide, the report adds, though interest rate risk varies by country. Among countries in the “moderate risk to profitability” category are:

• The United States ($553 billion in industry profits at risk).

• China ($211 billion).

• France ($150 billion).

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These countries face lower interest rate risk relative to Japan ($144 billion), South Korea, Sweden and Switzerland (all marked as facing “high risk to profitability”). In a worse position are Germany, Netherlands, Taiwan and Norway, all of which face a “very high risk to profitability.”

At the opposite end of the spectrum are South Africa and the United Kingdom (countries that face “low risk” to profitability;” as well as the U.S., Brazil, Ireland, Mexico and Australia, all of which confront “very high risk to profitability.”

“The profits of insurers [in these low-risk countries] will hardly deteriorate if interest rates stay low for the next five years,” report states. Moody’s adds that insurers in these markets generally offer fewer and less generous product guarantees, thus reducing their risk exposure.

Though a gradual rise in short- and long-term interest rates are to be welcomed, the report warns against a sudden and marked increase. A spike in interest rates would also be credit-negative for insurers, as policyholders would be have incentive to surrender their policies in exchange for contracts that offer superior yields. That, in turn, could prompt life insurers to liquidate assets and incur losses.

Legislative and regulatory changes — including the U.S. Department of Labor’s fiduciary rule, could “disrupt” sales of current products. Among them: variable and fixed indexed annuities. (Photo: Thinkstock)

Other risks

In addition to interest rate risk, the report notes, life insurers face geopolitical risks that fuel volatility in financial markets, which affect earnings of the carriers’ fee-based businesses and discourage policyholders from purchasing products.

Additionally, legislative and regulatory changes — including the U.S. Department of Labor’s fiduciary rule in the United States and pension reform in the United Kingdom — could “disrupt” sales of current products. Among them: variable and fixed indexed annuities.

The report observes, however, an eventual upside for life insurers as the global economy improves. “Economic growth is stabilizing and unemployment continues to decline, moderately supporting life insurance sales,” the report states.

The survey adds that stronger than expected growth of gross domestic product of more than 2 percent in developed economies could shift insurers’ credit outlook from negative to “stable.” Also meriting a stable outlook would be an increase of long-term interest rates globally by 150 basis points and “expectations of a smooth path of further increases.”

Consistent with other recent market research, Moody’s observes that life insurers are increasing investments in private bonds and commercial mortgage loans. But Moody’s notes that investments in alternative vehicles — such as hedge funds, derivatives, commodities and real estate investment trusts — is not “increasing anymore.”