A.M. Best Special Report: Shifts in Bond Portfolio Strategies Help Life/Annuity Insurers Navigate Low Interest Rates

OLDWICK, N.J.--(BUSINESS WIRE)-- The challenging low interest rate environment has been, and will likely remain, a key obstacle facing the life/annuity (L/A) insurance industry as organizations continue to invest new money as well as proceeds from higher-yielding maturing assets into new assets at current rates, according to an A.M. Best special report.

The Best’s Special Report, titled “Shifts in Bond Portfolio Strategies Help Life/Annuity Insurers Navigate Low Interest Rates,” notes overall investment portfolio yields, specifically bond portfolio yields, have continued to decline. The recent interest rate hike in December 2016 by the Federal Reserve, an increase of 25 basis points, was only the second rate hike in the last decade.

Reinvestment risk remains a large challenge and holdings repeatedly have been reinvested at lower rates since 2012. While aggregated industry bond portfolio yields have consistently declined to 4.71% in 2015 from 4.88% in 2014 and 4.99% in 2013, strategic investment decisions have helped mitigate further declines in book yield. If bond portfolio allocations had remained static as of year-end 2012, the industry’s bond portfolio yield would have declined to 4.54% in 2015 from 4.86% in 2013, a 10-20 basis-point difference in each of the last three years alone.

Private placement bonds have seen a major surge, increasing by 70% to $847.0 billion in 2015 from $497.3 billion in 2005. Due to the more limited availability of private placement bonds, and the required expertise to manage a private placement portfolio, just about 60% of L/A insurers held private placements as part of their bond portfolio as of year-end 2015, and 96% of all private placement bonds were held by insurers with investment portfolios greater than $10 billion.

According to the report, companies also have increased the duration of their overall bond portfolios. The L/A industry maintained a fairly tight average maturity of under 10 years prior to 2010; however, average maturities have increased to nearly 11 years since 2013.

Given the expectations of continued low interest rate environment for the intermediate term, insurers will continue to face the task of finding higher yields on assets in order to maintain operating profitability and manage spread compression. The trends of investing lower down the credit scale, increasing portfolio durations and growing allocations to alternative fixed income assets such as private placements are already noticeably underway. It is A.M. Best’s view that by introducing products with lower risk characteristics into an older in-force block of business, L/A insurers may be able to manage, perhaps at lower levels of profitability than in years past, a buffer against the continued low rate environment and declining yields.

To access a copy of this report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=257768.

A.M. Best is the world's oldest and most authoritative insurance rating and information source. For more information, visit www.ambest.com.

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Source: A.M. Best