Portfolio yields are expected to decline over the next 12 to 18 months as interest rates remain low. Those declines will be even more pronounced for carriers with growing general account product sales, according to a research note published by Fitch Ratings.
The declines will promote a further shift to riskier asset classes and investments in BBB-rated bonds, the lowest rung considered investment grade, Dafina Dumore, a director with Fitch, said in an interview with InsuranceNewsNet.
“We don’t expect a tremendous shift, it’s more on the margins,” she said.
Risk-averse life and annuity carriers, which are closely regulated, have no intention of placing their solvency in jeopardy, but the industry can expect carriers to alter their risk profiles slightly as carriers trade liquidity for yield.
Private bonds, which made up 28 percent of all bonds in life insurance company portfolios in 2014, rose by 2 percentage points compared with 26 percent in 2010.
Private bonds are issued through a private placement. Private bonds are less liquid than public bonds, which are issued through public markets.
Bond yields for life insurers declined to an average of 4.96 percent last year from 5.76 percent in 2010, Fitch said in its “Net Investment Income Dashboard” report.
The declines would have been even more pronounced had it not been for “make-whole” payments and prepayments on fixed income securities, Fitch also said.
Prepayments provide carriers with a temporary boost in cash flow and the funds are reinvested, but at lower yields since rates have gone down.
In the spring and early summer, market watchers were counting on the Federal Reserve to raise interest rates in the fall. However, the plunge in the stock market over the past two weeks has cast doubt on whether the Fed will follow through with a rate increase.
Analysts say a slow rise in interest rates would be the ideal scenario as life insurers could simply roll over their fixed-income investments into higher-yielding bonds without the disruption caused by a spike in interest rates.
Rate spikes tempt policyholders to surrender life policies or annuity contracts and reinvest the proceeds in contracts with higher yields.
“If rates increase a modest 25 basis points, I don’t expect a significant increase in surrender activity so liabilities remain stable, but the asset side of the balance sheet improves and reinvested at higher rates,” Dumore said.
In another sign that life insurers are trading liquidity for yield, carriers’ allocation to short-term bonds continued to decline last year from the previous year, while investment in long-term bonds continued its upward trend in 2014 from 2013, the report also said.
“The longer you go out, the less liquid the bond,” Dumore said.
As policyholders surrender their policies in exchange for contracts with higher rates, companies with longer-rated bonds will be more challenged to sell asset to cover the surrenders, she said.
“It’s not a prevailing concern because companies have sufficient liquidity but if there’s rapid increase in rates and they sell, they would have to sell bonds,” she added.
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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