If there’s an upside to the global financial market selloff, it’s that it forces insurance agents and financial advisors to rethink the quality of the assets in which their insurance and annuity carriers have invested.
Low interest rates have forced insurance carriers to stretch their fixed-income investments further in search of higher yields, and the search for better returns has meant carriers investing in longer-duration securities, or securities carrying a higher risk.
On average, bonds make up 75 percent of the invested assets of a life insurer. That level that has remained stable over an eight-year period ending in 2014, according to a December research note on the 2016 market outlook by Kroll Bond Rating Agency in New York.
But over the same period, high-risk assets as a percentage of insurers’ capital has gone from less than 50 percent to more than 70 percent, KBRA reports. Unlike banks, life insurers don’t provision for bond portfolio losses.
“Since the (2008) financial crisis, we have observed a shift to lower-rated corporates—mainly from the A/A- range to BBB+/BBB—driven by less availability of structured securities and the desire for higher yields,” wrote Andrew Edelsberg, senior director with KBRA.
Life insurance and annuity companies rely more heavily on investment earnings to pay claims than do their property-casualty siblings that look to underwriting. The higher the yield from investments, the better rate a carrier can offer life insurance policyholders.
No one is suggesting that life insurers are in imminent danger or that insurers’ fixed-income investments risk any major impairments — far from it.
Tougher regulations passed in the wake of the 2008 financial crisis and the designation of large insurers as Systemically Important Financial Institutions are designed to make sure insurers have more than enough to pay claims.
Many life and annuity companies spent the last several years reducing future liabilities by trimming living benefits and pruning annuity guarantees. Long-term care carriers, in the meantime, raised prices by hefty percentages.
So life insurance carriers themselves have been pretty good at operating more efficiently, according to Wall Street analysts, even if policy count and premium growth remains sluggish as Gen Y members don’t consider buying life insurance a priority.
Life insurance industry capital ratios and life insurance carrier operating performance have improved in a credit environment that remains “benign,” said Thomas Rosendale, assistant vice president with A.M. Best Co.
But it’s around the question of asset quality and ability of those investments to deliver the expected returns in the future where industry analysts say life insurance carriers aren’t in quite as good a place as they used to be, he added.
“We may have reached a bottom in terms of a benign credit environment, so together with changes in asset allocation that we've seen among insurers into high risk and less liquid investments, a jump in credit risk could be an issue for insurers,” Rosendale said.
The relaxation of underwriting standards in some loan portfolios is a signal that during the late phase of the credit cycle — which is where we are now — is when lending decisions are made that could lead to future losses, Federal Deposit Insurance Corporation Chairman Martin Gruenberg said in a fall report.
A.M. Best considers “credit risk,” or the ability of borrowers to continue meeting their debt payments, an emerging risk, Rosendale said.
State regulatory requirements regarding the use of captives, or in-house insurance companies used to reinsure liabilities, “have taken some of the conservatism — shall we say — out of the balance sheets” of carriers, he added.
Life insurers have generally been efficient about ringing excess capital out of their balance sheets, and any decline in asset quality still isn’t enough to offset the healthy growth in the industry’s capital ratios, analysts said.
“The combination of weak equity markets, downward ratings migration, and credit losses could eventually cause life insurers to pull back on some capital management, but we’re not at that point yet,” wrote Keefe, Bruyette & Woods analysts Ryan Krueger and Blake Mock in a research note to clients this week.
Debt ratings houses Fitch Ratings and A.M. Best Co. have each issued “stable” outlooks for the U.S. life and annuity sector in 2016. Positive trends surrounding life insurance carriers outweigh the challenges the companies face, at least for the moment, they said.
An even clearer picture of life insurance carriers’ financial positions will emerge over the next few weeks as companies report fourth quarter 2015 earnings.
InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at firstname.lastname@example.org.
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