OLDWICK, N.J.--(BUSINESS WIRE)-- A notable increase in surplus note issuances by the U.S. life/annuity (L/A) segment between 2014-2017 drove an overall modest rise by insurance companies industrywide, as issuances by the other major sectors declined in two of those three years, according to a new A.M. Best report.
The Best’s Special Report, titled, “Surplus Notes Usage Continues to Increase for L/A Segment,” states that the persistently low interest rate environment of the last decade has made surplus notes issuances particularly attractive to L/A writers. From 2014 to 2017, the amount of surplus notes issued by insurance companies increased to $49.5 billion from $47.8 billion, even though the number of insurers with surplus notes declined slightly, to 510 from 526. L/A writers contributed significantly to the increase, as the segment’s balance sheet rose to more than $32 billion from $26.9 billion.
The surplus notes balance for the property/casualty and health segments declined over the last two years. Surplus notes issuances for the health segment spiked in 2013, when insurance companies established Consumer Operated and Oriented Plans (Co-Ops), under the Patient Protection and Affordable Care Act. For the property/casualty segment, redemptions of surplus notes primarily in conjunction with mergers and acquisitions, without subsequent re-issuance led to a decline in balances to just over $14 billion in 2017 from $14.9 billion in 2014. The L/A segment continues to have the largest percentage of surplus notes, 7.8%, relative to total industry capital, followed by the health segment, at 1.9%, and the property/casualty segment at 1.8%. Insurers with high coupon rate notes may find lowering the cost of capital by way of replacements a challenge, given that investors need to be compensated for giving up high yields, as well as for risks associated with potential regulatory actions. Additionally, while interest rates remain low, A.M. Best expects insurers to issue the fixed-rate surplus notes as opposed to floating rate notes. As part of A.M. Best’s review of surplus notes, companies with a heavy reliance on surplus notes may be assigned weaker balance sheet strength assessments, depending on the use, terms and ability to service them.
A.M. Best looks at surplus notes in several areas in its rating process, including treatment in capital models, financial leverage analysis and quality of capital.
To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=277849.
A.M. Best is a global rating agency and information provider with a unique focus on the insurance industry. Visit www.ambest.com for more information.
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Source: A.M. Best