Annuity sales may have been fine this summer, but wild interest rate fluctuations made the third quarter a tough time to manage the investments supporting annuity obligations.
Walter Berman, the chief financial officer of Ameriprise Financial Inc., talked about the third-quarter rate rollercoaster Thursday, during a conference call the company held to go over third-quarter performance with securities analysts.
The Minneapolis-based company is reporting $543 million in net income for the third quarter on $3.3 billion in revenue, up from $503 million in net income on $3.3 billion in revenue for the third quarter of 2018.
The company’s annuity unit reported $120 million in operating earnings for the latest quarter on $617 million in revenue, compared with $129 million in operating income on $628 million in revenue for the year-earlier quarter.
The company’s protection segment, which sells life insurance and disability insurance, is reporting $57 million in operating income on $265 million in revenue, compared with $60 million in operating income on $328 million in revenue.
Here’s what happened to net flows for annuities, and life insurance product sales:
- Variable Annuities: Net outflows of cash fell to $691 million, on a beginning balance of $78 billion, from $826 million in net outflows, on a beginning balance of $78 billion, in the year-earlier quarter.
- Fixed Annuities: Net outflows increased to $511 million, on a beginning balance of $8.7 billion, from $199 million in net outflows, on a beginning balance of $9 billion, in the year-earlier quarter.
- Variable Universal Life and Universal Life: Cash sales fell to $74 million, from $79 million
- Term and Whole Life: Cash sales held steady at $2 million
- Disability Insurance: Cash sales held steady at $1 million.
Jim Cracchiolo, the chief executive officer, said during the call that the company is happy with its asset management and insurance and annuity businesses.
“These are well-managed, highly profitable businesses that deliver strong free cash flow and play an important role in how we serve our clients,” Cracchiolo said.
But rates fell sharply over the summer.
Cracchiolo said that low interest rates hurt universal life sales, but that the introduction of a new variable universal life product helped increase VUL sales.
“Overall, sales remained stable and helped to replenish the book,” Cracchiolo said. “We’re focusing on managing risk appropriately and ensuring we have the right product designed for the environment.”
Ameriprise is continuing to strengthen a program that protects the company’s variable annuity business against ups and downs in the investment markets, and it’s also adjusting some product features to manage risk, Cracchiolo said.
One way an insurer manages the risk associated with an indexed product or a fully variable product is to impose a “cap rate,” or a limit on how much of the investment index or investment portfolio gains the customer gets to keep.
Ameriprise has been lowering the cap rates on some indexed universal life products, and it has adjusted variable annuity prices and benefit designs, Cracchiolo said.
Interest Rate Assumption Unlocking
Under modern accounting rules, life insurers make assumptions about how long-duration products, such as annuities and long-term care insurance policies, will perform. Managers regularly review the assumptions to see whether the assumptions are still reasonable.
Companies may “unlock the assumptions,” and record gains or charges, when they feel they must change their assumptions.
For the third quarter, Ameriprise recorded $98 million in gains due to positive changes in assumptions about some aspects of the world, such as long-term care insurance (LTCI) premium rate increases, and LTCI policyholders’ increasing willingness to give up policies or accept reduced benefits.
The company recorded $118 million in assumption charges due to concerns about a “significant interest rate dislocation.”
Walter Berman’s World
Berman said during the Ameriprise call that interest rates matter to the company because the company’s annuity and insurance policy obligations last many years.
“Over 50 years, in some cases,” Berman said.
A U.S. life insurer relies mainly on high-quality bonds and similar types of assets to support long-term annuity and insurance obligations. Changes in interest rates affect the projected value of the obligations.
Given how long annuity and insurance obligations last, “we assess historical rate changes that can occur over a long period of time,” Berman said. “We only make changes to our assumptions when there is compelling evidence that warrants a change.”
Ameriprise has been assuming that, in the long term, rates will average about 5%.
In November 2018, the 10-year Treasury rate stood at 2.84%, Berman said.
Between November 2018 and last month, the 10-year rate dropped 1.75 percentage points — or 175 basis points — to 1.09%. For Ameriprise, that was the equivalent of getting a 60% pay cut on any 10-year Treasury holdings.
“During a 10-day period in September, the 10-year rate recovered 44 basis points then dropped again,” Berman said. “I believe that this movement is anomalous in nature and is not representative of the long-term expectations for the block over time. So, we left our ultimate rate at 5%.”
But Ameriprise is now assuming that getting to 5% will take longer than expected, Berman said.
“In the future, if we lower the ultimate interest rate by 50 basis points, we estimate that the impact would be $65 million after tax,” Berman said. “However, if we determine the environment was less volatile, we could change the grading period, if it was warranted, and that could reduce the impact.”
Links to information about the Ameriprise earnings announcement is available here.
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