By Cyril Tuohy
Judging from the fourth quarter crop of earnings reports, insurance carriers are steaming mad at the low interest rate environment and some C-suite executives seemed particularly vehement about the difficult rate environment facing the industry.
But why are rates still an issue? Aren’t they old news by now? Haven’t insurance managers learned to navigate the shoals of a lower-for-longer rate environment?
They have, analysts said, and that’s why as a group insurance carriers are projected to deliver earnings growth in 2015, even if analyst Ryan Krueger of Keefe, Bruyette & Woods earlier this year lowered its earnings projections for 2015.
Moody’s Investors Service in December issued a “stable” outlook on the industry for 2015.
John M. Nadel, managing director at Sterne Agee in New York, said that lower interest rates aren’t new, it’s true, but they are “real,” and they are making life for insurance manager difficult. When executives point to low rates, it’s OK to take senior managers at face value.
“I agree that lower rates aren’t new, but I disagree that carrier executives are using that as an excuse for not delivering on earnings,” Nadel said in an interview with InsuranceNewsNet. “This is not an excuse. It’s just real.”
Insurance carriers invest premiums and reinvest capital in 10-year Treasuries. But when they do, they receive less interest on their investments than they were getting on those same investments five years ago.
To be sure, it’s not rocket science. Yet, insurance carriers are powerless in the face of future interest rate movements.
Raymond James insurance analyst Steven D. Schwartz said the “real surprise” coming out of the fourth quarter is that low interest rates haven’t had much of an effect on life insurers’ balance sheets — with the exception of long-term care where liabilities stretch out 30 or 40 years.
“We’re in the fourth year of this as it’s been going on since 2011, so this quarter was a really positive surprise,” he said.
Analysts said insurance companies are sailing through an extended period of interest rate “headwinds,” and short of tweaking the levers of higher prices, trimming crediting rates, slashing agent commissions or culling head counts, there’s not much managers can do.
“That’s sort of where we are here,” Nadel said.
For carriers such as Prudential, American Equity Investment Life and Lincoln Financial, which are more dependent on spread business, life isn’t easy.
The difference between the amount in benefits paid out to annuity and life insurance contract holders and the amount earned from fixed-income investments, a measure known as the spread, narrows when rates drop.
Schwartz said that Aflac, Primerica , Torchmark, Unum, Symetra Financial and other companies with a business model less sensitive to interest rates and more reliant on mortality and stop-loss margins, have it easier than companies reliant on the spread.
But as a whole, the life insurance industry is doing fairly well.
“It’s delivering on earnings,” Schwartz said. Low rates amount to a “a headwind, not a balance sheet cliff – with the exception of long-term care.”
Carriers have benefited from rising asset prices, tweaks to their product mix and increases in portfolio investment risk, all of which have helped carriers offset low rates, Moody’s said.
To insurance carrier executives in the thick of the action — accountable to investors and policyholders — low interest rates are not helpful at all.
Kevin Hogan, executive vice president and CEO of American International Group’s consumer insurance division, didn’t mince words in the company’s earnings call earlier this month as AIG came up short of earnings forecasts by nearly 8 percent.
Hogan said sales of fixed annuities will “remain challenged in the current low interest rate environment” as the insurance giant continues to “maintain pricing discipline,” which usually means trimming back on benefits or charging more for products.
AIG’s conference call transcript revealed the mention of the phrase “interest rate” or “interest rates” 13 times among executives and analysts. At Prudential, the phrases were uttered 31 times during the conference call.
Mark B. Grier, vice chairman of Prudential, said lower interest rates had forced the company to increase the amount of debt characterized as capital. Prudential missed its earnings forecast by as much as 11 percent.
In December the company issued guidance of on-balance sheet capital capacity of $3.5 billion, but in the conference call with analysts revealed an on-balance capital capacity of only $2 billion. Prudential’s chief financial officer Robert Michael Falzon ascribed the $1.5 billion variance to fourth quarter interest rate declines.
Schwartz said Prudential’s forecast was based on interest rate assumptions from the end of the third quarter, which by December were “completely out of date,” Schwartz said.
“Prudential is a complete one-off,” he said. Even so, how does that happen at one of the nation’s largest life insurers?
“When you're doing asset adequacy tests and the like for something like Prudential, it's not easy and takes a while,” Schwartz said. “Rates moved down so fast that Prudential’s interest rate assumption was out of date almost immediately.”
From sales to capital ratios to profitability, it’s been tough slogging for insurance carriers as they press ahead through what appears to be yet another year of rate declines, a period analysts call “lower for longer.”
Notes from the January meeting of the Federal Reserve indicate no rush to raise rates. Welcome to a period of “lower for even longer.”
Like Nadel, John McCarthy, senior product manager for wealth management products at Morningstar in Chicago, said there’s only so much insurance carriers can do, from trimming crediting rates on annuities and cutting back on other living benefits, to raising prices to cutting agent commissions.
“The math is just not working in their favor,” McCarthy said. “Unfortunately that’s still the case.”
InsuranceNewsNet Senior Writer Cyril Tuohy has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].
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