While industry efforts have support operating margins to date, many are not sustainable
Oldwick, NJ., December 10, 2016 — 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.
Poor Underwriting Performance
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 report
A.M. Best believes L/A insurers have done a commendable job navigating through the post-
financial crisis period, including the unforeseen lower-for-longer interest rate environment. In
an ongoing effort to stave off significant negative trends in portfolio yields, the L/A industry
has strategically pivoted product offerings, repriced existing products, lowered guaranteed
benefits, and aggressively managed expense levels. While these actions have supported
operating margins to date, many are not sustainable.
It is recognized that through this period, L/A insurers have also benefitted from a rather
benign corporate credit market, a seemingly never-ending boost from the U.S. equity markets,
pockets of moderate economic growth, low cost financing provided by the capital markets,
and a much needed overall improvement in enterprise risk management (ERM). However, for
those companies with significant overhang from poorly written legacy blocks of business, the
pain is still being felt as the process to “wall-off,” hedge, and manage down these exposures
remains expensive and time-consuming.
The L/A industry also faces uncertainty from a newly elected administration, increased merger
and acquisition activity (including from non-traditional and foreign buyers), accelerated
advances in technology, and overall low domestic growth. All of these items together have
helped to further depress top and bottom line performance, slow capital growth trends, and
stifle advancements in reaching the end policyholder more quickly and efficiently.
To access the full copy of this briefing, please visit here.
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