Are current operating margins sustainable?
OLDWICK, N.J., December 19, 2016 — A.M. Best has revised its outlook to negative from stable for the U.S. life/annuity (L/A) industry, citing increased volatility across economic and regulatory fronts, which includes continuing interest rate pressures.
The Best’s Briefing, titled, “Increased Market Volatility Drives Rating Outlook Negative for U.S. Life/Annuity Industry,” states that L/A insurers have done a commendable job navigating the post-financial crisis period.
The industry has strategically pivoted product offerings, repriced existing products, lowered guaranteed benefits and aggressively managed expense levels to stave off negative trends in portfolio yields. While these actions have supported operating margins to date, many are not sustainable.
The L/A industry also faces uncertainty from the newly elected U.S. president and his administration, increased merger and acquisition activity (including from non-traditional and foreign buyers), accelerated advances in technology and overall low domestic growth. Combined, these items have helped to further depress top and bottom line performance, slow capital growth and stifle advancements in reaching the policyholder more quickly and efficiently.
On the regulatory front, the L/A industry has been diligently preparing for the new fiduciary responsibilities set forth by the U.S. Department of Labor. The scope of these regulatory requirements has taken on new meaning with respect to compliance costs and has been a significant distraction for insurers’ management teams. Other issues include the introduction of principle-based reserving and the use of captives. A.M. Best remains concerned about the continued use of financial engineering and overall reliance on reinsurance, which qualitatively diminishes its view of capital adequacy in the industry.
Underwriting performance flat, net book yields decline
Underwriting performance has not improved for the L/A industry as a whole, and the industry’s investment portfolios, heavily weighted toward corporate debt holdings, have seen net book yields decline by 63 basis points (bps) to 4.74% in 2015 from 5.37% in 2010. Bond portfolio yields have declined even further by 93 bps over that same period.
Since the recent U.S. presidential election, longer-term rates have had some rapid upward movement, but only to where the market was in November 2015. The speed and level at which interest rates move will have a meaningful impact, one way or the other, on insurers’ results and A.M. Best believes this increased volatility bears watching. Continued strong equity markets also pose the risk of reversing course, leading to increased reserve requirements and lower fee income for many carriers.
An overall benign credit environment, as well as generally favorable capital market conditions, had helped support A.M. Best’s previous stable outlook for the L/A industry. It is now more likely that the U.S. economy is poised to see a volatile transition impacting its equity, interest rate and credit markets. This coupled with uncertain regulatory burdens and slow premium growth for life and other products remains an industry-wide dilemma. Finally, disruption from increased merger and acquisition activity and the industry’s historic slow incremental approach in the face of a rapidly changing landscape, has led A.M. Best to anticipate more rating downgrades than upgrades in the near term.
Excerpts from the briefing
- After championing all the progress made on the expense side, insurers have been somewhat
reticent to make the aggressive IT spends necessary to compete with more nimble new
entrants that do not bring with them antiquated systems. In addition, by maintaining legacy
systems, many insurers are finding it difficult to leverage the more modern approaches to
predictive modeling in improving risk selection and claims handing. Having said that, some
effort has been made to improve the direct-to-consumer sales model and improve the overall
customer experience, but much more work is needed on this front. - On the ordinary life insurance side, carriers are still faced with an overall low growth rate
for their products. Insurers are therefore focused on simplifying their products and finding
creative ways to access the consumer directly. In addition to a generally modest growth rate,
many insurers are continuing to aggregate longevity risk on their books. A.M. Best sees this
as a growing risk, which for the time being remains manageable. With respect to fixed and
fixed-indexed annuities (FIAs), A.M. Best remains wary of the potential for a growing arms race
as FIAs with customized indices now represent over 30% of industry new sales. - Finally, many new riders have been added to insurance products, including long-term care riders, which
have been added to life products, variable annuities, and even fixed annuities, although they
remain untested. Specific to the retirement space, inflows will be negatively impacted by any
decline in the equity markets coupled with continued relatively low interest rates. Additionally,
the shift from actively managed funds to passively managed funds is a headwind to insurers
with asset management businesses who must now re-engineer their fund offerings. - An overall benign credit environment, as well as generally favorable capital market conditions,
had helped support A.M. Best’s previous stable outlook for the L/A industry in the face of
various challenges. However, it is now more likely that the U.S. economy is poised to see a
volatile transition impacting its equity, interest rate, and credit markets. - This, coupled with uncertain regulatory burdens and slow premium growth for life and other products, driven
in part by the inability to effectively access the middle market and direct consumer, remains
an industry-wide dilemma. Finally, additional uncertainty around the regulatory environment,
disruption from merger and acquisition activity, and the industry’s historic slow incremental
approach in the face of a rapidly changing landscape, lead us to anticipate more downgrades
than upgrades in the near term and, therefore, A.M. Best’s outlook for the L/A industry for 2017
is changing from stable to negative.
To access the full copy of this briefing, please visit here.
A.M. Best is the world’s oldest and most authoritative insurance rating and information source. For more information, visit here.
