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Asset-liability matching is critical for insurers in order to match their long duration liabilities, particularly interest-sensitive business—such as fixed and variable annuities, universal life with secondary guarantees, pre-need products, long-term disability and long-term care—with assets that will generate positive spreads, minimize reinvestment risk and achieve their investment income targets.
Insurers have historically preferred the fixed-income securities (FIS) asset class—U.S. government, foreign government, U.S. state and special revenue (municipals), utilities, corporate and asset-backed securities—due to their generally fixed returns and high credit quality. Since a large percentage of an insurance company’s investment portfolio typically consists of FIS that were purchased at higher yields than currently are available, portfolio yields are likely to decline unless insurers reinvest in higher risk securities. In the decades prior to the financial crisis, FIS offered attractive yields that allowed companies to match their assets with long-duration liabilities, with few concerns regarding minimum interest guarantees. However, from 1997 to 2011, net yields for FIS have been declining fairly consistently, which has increased the challenge to manage investment portfolios.
To counteract the impact of low interest rates on spread compression and earnings volatility, insurers are strategically de-risking their legacy product portfolios. Strategies include exiting, repricing or de-emphasizing certain business lines, particularly interest-sensitive businesses, and in some cases, revising their investment allocations to stretch for yield. However, other companies, instead, have de-risked their investment portfolios, which may accelerate investment yield deterioration.
For a full complimentary copy of the briefing, please visit www.ambest.com/press/101506lifeannuitybriefing.
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