Mixed Messages On Low Interest Rates?

By Linda Koco
AnnuityNews

The fortunes of the fixed annuity business are so closely tied to the movement of interest rates that fixed annuity professionals follow rate developments closely. Right now, some professionals might be getting cross-eyed, due to what seems to be mixed messages in this area.

On one the hand, many carriers that issue fixed annuities are continuing to report that the prolonged low interest rate environment of the past year still puts pressure on to capital reserves and carrier ability to support certain fixed annuity guarantees.

Analysts and other annuity watchers carry that message forward. For instance, in this morning’s bylined article by Cyril Touhy in InsuranceNewsNet’s daily newsletter, a Deloitte Consulting expert commented on the situation.  Low interest rates are “putting pressure on the bottom line” of annuity and life insurers who typically espouse conservative investment philosophies due to the financial guarantees for which they are on the hook, Boris Lukan, leader of the insurance mergers and acquisition practice in the U.S., told Touhy.  

Meanwhile, analysts at A.M. Best Co. recently published a special report touching on the issue. Low interest rates continue to challenge the investment portfolios of life insurers, particularly among companies with significant exposure to fixed annuities, they said. This is impacting exposure to liquidity risk, as will be seen below.

On the other hand, there is a lot of talk about the rising interest rate environment and how it is helping to fuel annuity sales.

For instance, Beacon Research recently reported that fixed annuity sales in third quarter reached $22.5 billion, the highest fixed annuity sales since the second quarter of 2009.That growth is largely due to “some of the highest interest rates and spreads we’ve seen in more than a year,” said Beacon President Jeremy Alexander in an industry sales report from the Insured Retirement Institute (IRI).

Alexander pointed to the current spread between the one-year Treasuries and 10-year Treasuries as an example. “This spread has increased by more than 100 basis points since the end of 2012,” he said, adding that “credit spreads are rising, and this has enabled carriers to raise the credited rates on their products.”

The rate increases are more like small upward blips than giant leaps. But they are, on average, approaching 3 percent, a level that makes them more competitive with bank certificates of deposit than last year.

Specifically, according to the Fisher Annuity Index, the average fixed annuity crediting rate on Dec. 10 was 2.87 percent.  Last year, on the same date, the average was 2.48 percent. On CD-type fixed annuities, the rates vary by guarantee period, but they are still up. (See tables.)

There have also been various third quarter reports from a few carriers  which point to how the rising interest rate environment is helping with annuity sales (or management of risk exposure, in some cases).

The combination of these things means a modest form of rate relief — in the form of higher crediting rates — has arrived for fixed annuity professionals and their customers, but carriers are still struggling with the consequences of the lengthy low rate environment. Both trends are happening at the same time. This is not so much a matter of mixed messages as two sides of the same coin.

Carrier challenges

Best’s comments about life carrier challenges in the low interest rate environment are illuminating.

The Best special report does not deal with the impact of interest rates spreads on fixed annuity crediting rates or sales, George Hansen pointed out in in an interview. But it does look at what is happening at life carriers offering fixed annuities in the context of their own investments.

As it turns out, the two trends are linked. According to the report, fixed annuity carriers are “under increased pressure to maintain portfolio yields in an effort to support credited interest rates offered in the highly competitive fixed annuity marketplace.”

In response, the carriers — especially the larger carriers — are taking more risk in their investments today than three years ago, said Hansen, who is managing senior financial analyst at Best. “They are doing this to get yield,” he said.

Specifically, they are increasing investments in asset-backed securities and commercial mortgages, which are not liquid, he said. Should a “run on the bank” (i.e., an annuity company) occur, these carriers could encounter potential liquidity risk, said Hansen, who is an actuary.

This matters because “it will be harder for the larger carriers to handle a large spike in fixed annuity surrenders” during stressful market conditions, Hansen said.

What about mid-sized annuities carriers? They have “more of a cushion,” he said, because, so far, they have been “less aggressive” in their investment portfolios than the larger carriers. Put another way, they are not stretching for yield by increasing their investments in asset-backed securities and commercial mortgages. They are therefore are “slightly higher” in terms of liquidity.

But if the mid-sized fixed annuity carriers should start following the investment path now being taken by the larger carriers, they too would have less liquidity, he said.

The higher yields the carriers are seeking for their investments may improve profitability, Hansen allowed, but the tradeoff is that carriers face increased liquidity risk due to some of the investments. This has been an ongoing issue for the past few years, he indicated. “Liquidity ratios peaked at over 200 percent in 2009. Now, they are down to 170 percent.”

To keep on top of trends in this area, Best is “closely monitoring” the increasing liquidity risk with the emerging changes in company portfolios. It is using liquidity modeling to measure a company’s cash needs under stressed scenarios.

In general, stress scenarios have greater impact on companies with fixed annuity business than on life companies that do not offer fixed annuities, according to the company. That’s because fixed annuities allow greater policyholder access to funds than do life policies and are held for shorter periods of time, Hansen explained, so they are more likely to likely to see rapid cash outflows than life policies.

Agents and advisors who are doing due diligence on fixed annuity policies might want to add that issue to their list of considerations (as well as crediting rate, policy features, etc.). “For instance, they might want to find out what the company is investing in,” said Hansen.

That information might not be easy to get, but agents and advisors can always ask.

Linda Koco, MBA, is a contributing editor to AnnuityNews, specializing in life insurance, annuities and income planning. Linda may be reached at [email protected].

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Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].