Many U.S. life insurers are coping with low interest rates by investing in more lower-rated, higher-paying bonds and notes, and that strategy could backfire if the economy tanks, according to a new analysis from Moody’s Investors Service.
Moody’s rating analysts came up with their own, rough, life insurer shock test by seeing what might happen to the insurers’ bond portfolios, and risk-based capital (RBC) levels, if bonds performed as poorly as they did during the 2001-2002 downturn.
In 2001-2002 Repeat scenario, the median issuer’s RBC rating would fall about 15%, the analysts estimate.
That means half of the issuers would face declines less than or equal to 15%, and half would face declines of at least 15%.
But “insurers with a high proportion of securities at the lower end of A-rating and Baa-rating are most susceptible to RBC ratio declines,” the analysts write.
Life Insurer Investment Basics
A bond is a security that a company or other issuer uses to borrow money.
Analysts often refer to “fixed-income securities,” rather than to bonds, because, technically, a bond is a security with a term of more than 10 years.
A note is a debt security with a term of one to 10 years.
Life insurers also invest in some types of instruments that are lumped in under the “fixed-income investment” heading.
As a rating agency, Moody’s is one of a handful of organizations that “rate” fixed-income securities, meaning that they decide how safe or risky the borrowers are. Borrowers with higher credit ratings, that look as if they’re more likely to make their payments, pay lower rates to borrow money; borrowers with lower ratings, that look more likely to default, pay higher rates.
Moody’s also give life insurers financial strength ratings. Those ratings show how likely Moody’s thinks life insurers are to make good on insurance and annuity obligations.