Although many precursors to the 2008-09 financial crisis are repeating today, AM Best believes the life/annuity (L/A) industry is much more resilient than a decade ago and well-positioned to navigate future challenges.
Still, many of AM Best’s concerns in the run-up to the financial crisis exist today, and a new special report looks at how prepared L/A insurers are in the event of a new economic downturn.
The new Best’s Special Report, titled, “Are Life/Annuity Insurers Prepared to Weather Another Economic Downturn?” notes that prior to the 2008-2009 financial crisis, the industry had been riding the tailwinds of favorable years, and that economists were expressing concern about global economic volatility, credit cycle downturns, corrections in equity markets and an inverted yield curve that first started appearing in 2006.
Macroeconomic conditions in the United States soon became more unfavorable as the effects of the subprime crisis started to emerge. The financial system was flooded with a growing number of loan securitizations as new loans, and the securities derived from them, began to challenge market stability and diminish companies’ ability to manage risk effectively. These factors in combination presaged the financial hardship.
In response to the crisis, many L/A insurers reduced holdings of collateralized mortgage obligations and increased their holdings of cash and cash equivalents, as well as U.S. government securities in an effort to maintain liquidity. In addition, there were increased allocations to corporate bonds.
The overall quality of L/A insurer bond portfolios stabilized as the level of investment grade holdings increased to levels seen before the crisis. Within the investment grade category, however, there has been a steady increase in allocations to Class 2 bonds, with BBB rated bonds having the highest exposure.
From a product perspective, one of the largest shifts since the financial crisis has been the migration to fixed annuities from variables. In 2007, approximately 60% of total annuity premiums could be attributed to variable annuities. By 2018, the overall percentage had dropped to nearly 40%.
Given the current geopolitical, interest rate and equity market environment, economic volatility may well increase. As L/A insurers’ investment portfolios have migrated toward higher risk, with allocations to untested assets such as collateralized loan obligations growing and holdings in mortgage and alternative assets increasing, today’s global economic conditions resemble those of 2007. Shifts toward more fixed annuity products will help L/A insurers navigate the future, as these products generally have less policyholder optionality and may be more manageable from a risk management perspective. Available capital also has grown steadily since the financial crisis; however, as economic conditions change, so may risk charges.
The L/A industry also will face several accounting and regulatory changes over the next few years. Term products likely will see relief from less redundant reserves, and variable annuity reserves and capital requirements will change to better reflect the economic benefits of hedging and eliminate non-economic volatility. Companies were already identifying the need to improve legacy technology and upgrade systems before the financial crisis. AM Best expects that pace of such changes will quicken as technological advances create more opportunities to accomplish these goals.
To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=286972.
AM Best is a global rating agency and information provider with a unique focus on the insurance industry. Visit www.ambest.com for more information.