The publicly traded U.S. life insurers Moody’s Investors Service rates reported a slight aggregate decrease in operating profitability sequentially, as they position themselves for significant uncertainty in the markets for the remainder of the year.
Although year-over-year operating profitability remains lower than in first-quarter 2022, Moody’s said companies are benefitting from rising interest rates through higher yields on floating-rate and new or reinvested fixed income investments, improving sales and positive equity markets in Q1 2023. Aided by the rising rate environment and consumers' search for reliable returns, fixed annuity sales hit another all-time high. On the negative side, companies continue to experience higher expenses because of persistent inflation, lower than expected variable investment income and contributions from alternative investments, and a rising risk of recession. Life insurers implemented the Long-Duration Targeted Improvements accounting standard in Q1 2023 and provided additional disclosures for their restated financial statements. Although the new accounting standard does not affect an insurance companies' cash flows, it does provide new insights into company profitability. Below are the key themes for Q1 2023:
Profitability stabilizes with flat operating income and higher investment income: Operating results remained flat, with sequential quarterly operating earnings declining 2%. Although alternative income and asset-based fees remain depressed, relatively strong sales amid declining COVID-19 claims and an improving equity market that bolstered net income were positive developments in Q1. However, aggregate operating and net income of $8.2 billion and $1.4 billion declined 11% and 89%, respectively, in Q1 2023 compared to Q1 2022.
Higher annuity rates continue to boost demand for interest-sensitive insurance products: Total individual annuity sales reached another all-time high of more than $30 billion in Q1 across Moody’s rated public life insurers, with fixed annuity sales over $18.5 billion, while variable annuities continued their fall from favor amid continuing market volatility. Aggregate individual life insurance sales declined 5% in Q1 2023 compared to the same quarter in 2022.
Commercial real estate and banking exposures are top of mind: Concern about commercial real estate, and particularly office exposure, remains a key theme for the sector. Companies disclosed significant details on their CRE exposures during their investor calls. Additionally, given the recent collapses of Silicon Valley Bank and Signature Bank, and the pressure on other regional banks, companies provided enhanced disclosure on exposure to regional banks and also addressed questions about liquidity.
Profitability remains flat, as insurers transition to LDTI
How LDTI affected earnings: Moody’s generally expects operating earnings to be higher for life insurance products, at least in the early years, because of lower deferred acquisition costs amortization. Meanwhile, adjusted earnings for variable annuity sellers will generally be lower, especially to the extent companies previously reserved for their VA blocks using SOP 03-1, since more of the fees will be moving below the line. There will also be less fee volatility as some attributed fees will now be below the line. More significantly, operating earnings will likely be less volatile because of the smoothing mechanism in the reserves for the mortality impacts on traditional life insurance products.
Focus on CRE: Given the heightened concerns with commercial real estate exposures, and specifically office exposure, most insurers discussed their exposures to this asset class. Overall, companies expressed confidence that their CRE exposures are modest and manageable even in extreme stress scenarios.
Aflac indicated that it is seeing pressures in the CRE market with a current focus on the difficult market for office leasing. The company expects approximately $500 million (6% of total mortgage holdings) to enter some form of foreclosure. US life insurers' total exposure to CRE is around $900 billion, or 17% of total cash and invested assets as of year-end 2022.
Commercial mortgage loans account for most of the exposure, with around $600 billion, or two thirds of total CRE exposure. However, despite the industry's large exposure to CRE, most holdings are investment-grade securities and senior loans, which are well protected against losses. In Q1, companies indicated that the average loan-to-value ratio for CRE was between 40% and 65%, with the average debt service coverage ranging between 2.0x and 2.5x.
Banking crisis garners attention: After the recent collapses of Silicon Valley Bank and Signature Bank, and the recent sales of First Republic Bank and Credit Suisse, insurers addressed concerns regarding their investments in regional banks. Almost all companies reassured investors that exposures to the banking crisis remain minimal. Life insurers' lack of material exposure to Silicon Valley Bank, Signature Bank, and regional banks as a whole aligns with Moody’s previous analysis of the industry’s exposure to the banking crisis. Although any individual insurer's exposure to regional banks is limited, even such limited exposure could still incrementally increase losses when considered among other assets that could be stressed, such as commercial real estate.