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North American Life Insurers' Inflation Shielding Looks Strong: Analysts

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What You Need to Know

  • Fitch says a weak U.S. economy would squeeze life and annuity sales in North America.
  • Rising government bond rates would be great for life insurer capital levels.
  • High capital levels could help North American life insurers buy life insurers elsewhere in the world.

In a normal bad economy, North American life insurance and annuity issuers should do well.

Analysts at Fitch Ratings give that assessment in a look at how they think the world’s insurers might do in a world where government banks around the world are pushing up interest rates in an effort to hold down prices.

Analysts at Fitch and its competitors help lenders and insurance buyers decide how strong insurers are. The ideas that go into their ratings affect how much insurers have to pay when they issue bonds, and how much they can charge for the life insurance policies and annuities they sell.

An economic slump could hurt North American life insurers’ sales, but the effects on profit margins and reserves would likely be neutral, and rising rates would be great for those life insurers’ investment yields, the analysts predict.

What It Means

Some of the same rating analysts who have said for years that North American life insurers could handle the claims from a major pandemic — and, when COVID-19 hit, turned out to be right — now say that those life insurers can handle a normal bad economy.

The Bad Economy Scenario

For North America, the analysts assume that a normal bad economy means:

  • Inflation of 9% this year, 6% next year and 3% in 2024.
  • Yields on 10-year U.S. government bonds averaging 3.25% this year and 3.75% over the following two years.
  • Gross domestic product growth falling to 1.5% this year, 0.5% next year and 1.5% in 2024.

The Fitch analysts created charts showing how their baseline bad economy scenario could affect different types of performance measures at different types of insurers.

The North America Details

When a life insurer issues a life insurance policy or annuity contract, it takes in premiums today, invests the premiums, and then uses a combination of premium revenue and earnings on the investment portfolio to pay benefits later.

Because, for regulatory reasons, the typical life insurer in North America tends to focus heavily on investments in high-grade corporate bonds, with some mortgages, mortgage-backed securities, government bonds and other interest-sensitive holdings, rising rates can do a lot to increase their investment yields.

For North American insurers of all kinds, the effects of the baseline bad economy scenario are positive, the analysts say.

For North American life insurers, the effects on reserves and profit margins would be neutral, and the effects and sales volumes would be negative.

For North American health insurers, the effects on reserves and sales volumes would be neutral, and the effects on profit margins could be positive.

The World

For life insurers in Europe and the Asia Pacific regions, which use different investment and accounting rules, the effects of the baseline scenario could be good for traditional life insurance profit margins but bad for traditional life sales and investment returns.

Fitch sees the baseline scenario being neutral for investments and reserves for investment-oriented life insurance products in those regions and bad for both sales and profit margins.

In Latin America, the “bad economy” scenario would be bad for traditional life sales volume, good for traditional life profit margins, and neutral for all other aspects of the traditional life and investment-oriented life business.

The Warning

Fitch notes that the baseline economic scenario it used to produce the analysis is simply an idea about what a bad economy could like, not a prediction about what the economy will look like.

The M&A Future

The Fitch analysis shows that, in its bad economy scenario, North American life insurers may have weaker profits but stronger investment returns than life insurers in Europe and the Asia Pacific regions.

In recent years, life insurers in North America and Europe have tended to focus on the Asia Pacific region when making life and health deals.

If the Fitch analysis is correct, its baseline bad economy scenario might add to the acquisition opportunities in the Asia Pacific region and create some acquisition opportunities in Europe.

(Photo: Emilia Mariana Ungur/Shutterstock)