Higher interest rates expected to help insurers post good Q2 results

Rising interest rates will drive the story that life insurance companies report during second-quarter earnings season beginning next week.

The details will determine whether the bottom-line narrative is good or bad as a result.

Globe Life, historically one of the earliest insurers to report earnings, will release its second-quarter numbers this afternoon and speak with analysts tomorrow. Other industry leading insurers, including American International Group and Lincoln Financial, will begin reporting quarterly financials late next week.

The expectation is that investment income will be up, said Doug Baker, a director in Fitch Ratings U.S. insurance group.

Investment returns, particularly in the variable investment income, alternative portfolios, were really strong in 2021 and drove "outsized results," he noted. Those investment returns turned bearish through 2022, particularly the second half of the year and early this year.

"To the extent that there's a rebound there, we can see that boosting earnings," Baker added, "although I would say it's probably looking more stabilized around long-term historic return targets and that's going to vary by company."

In short, a larger investment asset base, higher reinvestment rate and alternative investments in private equity, hedge funds and real estate should all help insurers post strong net investment income, Baker explained.

Higher interest rates mean surrenders

There's also a downside to higher interest rates in the form of increased annuity surrenders as it encourages owners to make investment changes. Several insurers posted higher surrenders in the first quarter, and analysts will be watching those numbers again.

"With rates up this high, it would be unreasonable to assume that there would be no additional surrenders and companies price for that," Baker said. "I think we're still expecting that to be sort of favorable to where that was priced at initially."

The tentative acquisition of American Equity by Brookfield Reinsurance, despite the insurer's higher surrenders in recent quarters, shows how life insurance companies are valued in the market. Announced in late June, Brookfield will pay $55 per share to buy all the American Equity shares it doesn’t already own, according to a statement.

Several suitors attempted to acquire American Equity in recent years, including a takeover bid that led to a partnership with Brookfield. It appears that the Brookfield offer is well above previous offers, representing a 35% premium on American Equity’s closing price at the time.

For public companies in general, the Wall Street Journal expects a "remarkably bad" quarter due to sluggish sales and supply and demand issues. Analyst estimates are for earnings per share at companies in the S&P 500 falling by 8.1% from a year earlier, according to Refinitiv.

The impact of accounting changes

The start of 2023 saw insurance companies transitioning to the new long-duration targeted improvements (LDTI) accounting standard. This new standard will continue to impact how financials are reported, Baker noted.

The LDTI accounting standard "significantly changes the accounting and disclosure requirements for long-duration insurance contracts," S&P Global Market Intelligence reported in May. Companies are now required to review and update cash flow assumptions used to measure liabilities for future policy benefits for traditional and limited-payment contracts at least on an annual basis.

It will be interesting to see how LDTI impacts income volatility, Baker said.

"I'm not sure that companies have really been all that out there with how much volatility they expect that to introduce into earnings quarter over quarter," Baker said. "Different people are going to see different value in that. From Fitch's perspective, we don't think LDTI changes the underlying economics of the products and so we're trying to work through how we handle that and a lot of that is going to hinge on that the level of volatility we see. I do think there will be some differences across companies."

Senior Editor John Hilton covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected]. Follow him on Twitter @INNJohnH.

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