Higher interest rates drive ‘improving’ 2024 outlook for life insurers, Fitch reports

Fitch Ratings has revised its sector outlook for North American life insurers to "improving" from "neutral" for 2024, according to its outlook report for the sector.

Fitch expects the Fed’s monetary tightening to cease and potentially pivot towards monetary easing. “North American life insurers will still benefit from the higher interest rate environment in 2024, which will facilitate top-line growth and enhance margins,” said Senior Director Jamie Tucker. “Their strong balance sheets should partially mitigate potential slowdowns in economic growth or macroeconomic volatility.”

Macro and secular shifts continue to make commercial real estate a pressure point. While CRE exposure is material, property and geographic diversification make life insurer losses largely manageable relative to capital. Insurers most vulnerable to heightened pressure and losses will be those holding larger office concentrations and higher volumes of near-term maturities.

Another area to watch closely for life insurers in 2024 will be continued alternative Investment manager (Alt-IM) tie-ups. Fitch expects further integration between Alt-IMs and insurers with relationships more immediately focused on minority stakes and/or investments in sidecars or offshore reinsurance platforms, though the effect thus far has been neutral.

More Alt-IM/life insurer partnerships will also lead to increased allocations in private credit. “Banks’ increased retreat from lending could lead to some life insurers investing in less liquid, less transparent and more esoteric investments, which in a credit market downturn will warrant added scrutiny,” said Tucker.

Reinvestment rates will continue to rise

Currently, reinvestment rates are materially exceeding roll-off yields, improving margins. Fitch
expects portfolio rates to continue to increase in 2024 as interest rates stabilize at higher levels. While Fitch expects the Federal Reserve’s monetary tightening to cease and potentially pivot toward monetary easing, life insurers will benefit from asset rotations, and interest rates will remain materially higher compared with recent history. The higher interest rate environment is beneficial for most major product lines and alleviates pressure on certain legacy long-tail liabilities. Sales of spread-based liabilities will also remain robust, particularly fixed-rate annuities.

Policyholder behavior manageable due to structural protections

Policyholder behavior remained predictable in 2023 relative to movements in interest rates,
including through the bank failures in March. Lapsation/surrender activity remains elevated
compared with recent years, which Fitch expects to persist in 2024 due to higher interest rates
resulting in a wider set of attractive investment opportunities available to policyholders. However, withdrawal activity is not expected to materially deviate from dynamic lapse rate assumptions, barring a material upward shock in rates. Unrealized losses are expected to remain material for the industry based on the level of interest rates. Fitch expects strong ALM practices to mitigate the probability of its rated universe becoming forced sellers, including through cash flow and duration matching of assets and liabilities.

Credit losses to remain low

The credit environment is expected to remain relatively benign in 2024. However, certain asset
classes, such as leveraged loans, will be pressured by the higher interest rate environment, though they continue to weather the macroeconomic conditions and global uncertainties. Fitch expects life insurers to continue to shift portfolios to private asset classes to capture the illiquidity premium, though the higher interest rate environment decreases the likelihood that life insurers will overreach for yield in ways that increase vulnerability to a large market shock.

Favorably, exposure to below-investment-grade bonds remains low compared with historical
averages, with the industry generally shifting towards private assets as opposed to high yield,
though there has been a modest uptick in the proportion of bonds rated ‘BBB’ over recent periods, which could be vulnerable to rating migration in a credit market downturn. Fitch recognizes that performance across the various alternative investment managers (AIM) tie-ups may vary given that this strategy has not weathered a material credit market downturn.