Life & Annuity

Limited COVID-19 Impact On US Life & Annuity Operating Performance Metrics

While there has been some increased volatility from quarter to quarter, there has not been a steady upward trend

In its Best’s Special Report, titled, “Limited COVID-19 Impact on U.S. L/A Operating Performance Metrics,” AM Best states that operating performance is a leading indicator of future balance sheet strength and long-term financial stability. Access the full report here.

Benchmarking is essential to AM Best’s rating process, allowing us to compare the performance of a rating unit to its peers, composites, and the industry as a whole. AM Best examines absolute results and volatility levels across the industry.

Benchmarking is conducted relative to the building blocks of AM Best’s ratings process, the issuer credit rating (ICR), the market composite/line of business, or other financial and non-financial indicators. We use historical data for benchmarking, as well as current and potential future data trends. AM Best’s ratings also recognize insurers’ return characteristics through their business profiles and enterprise risk management relative to their unique risk profiles.

Mortality Risk Increases Due to COVID-19

Total industry death benefits paid increased dramatically in 2020, and continued to rise through 2021. From the fourth quarter of 2017 to the fourth quarter of 2021, death benefits paid rose over 28%. As such, companies with a business mix leaning toward life products were more at risk to increases in benefit payments, while simultaneously navigating balance sheet risks, where credit losses have been relatively minimal. While there has been some increased volatility from quarter to quarter, there has not been a steady upward trend, regardless of business line composite. Longevity benefits have offset any impact of COVID-19 mortality on companies with longevity exposure, and the increase in claims has not significantly diminished the industry’s solid pretax operating results, which grew by over 30% in 2021 compared to 2020.

Benchmarking Operating Performance

Operating performance is a leading indicator of future balance sheet strength and long-term financial stability. AM Best evaluates the diversification of a company’s income sources, the sustainability and stability of historical performance, and how the company will navigate certain market and macroeconomic conditions. Metrics considered when analyzing operating performance can include return on equity (ROE), premium growth, net yield on invested assets, earnings trends and expense ratios, among others. The Appendix details these ratios for life/annuity insurers, broken out by percentile for operating performance assessment, financial strength rating (FSR) categories, and line of business.

A company’s volatility depends on its risk appetite and risk management. AM Best uses a number of metrics to measure volatility, which can significantly affect balance sheet strength and operating performance. Volatile earnings generate uncertainty and can result in an irregular accumulation of capital. If results are consistently positive, volatility becomes less of a concern. As the data in the Appendix shows, performance metrics deteriorate as you move down the operating performance assessment and FSR category scales, and the gap between the top and weaker performers generally widens.

Further, the frequency of operating losses at stronger companies is notably lower than at weaker-assessed companies. Over the last 20 years, companies with an operating performance assessment of Very Strong did not report an operating loss at all, compared to 5.9% of the time for Strong companies and over 35% of the time for Marginal companies. Additionally, the severity of those losses as a share of capital and surplus is also notably lower.

Lower volatility in net premiums written translates into a stronger operating performance assessment. Growing a book of business successfully takes time and capital. Companies generally do not see returns quickly. Those insurers that do grow rapidly may be offering more client-friendly features, commissions, and crediting rates, but they may not translate into
profitability. High growth is unsustainable.

Companies assessed as Stronger often have more stable trends or patterns and diversification across product lines, leading to consistent top-line growth. More consistent premium growth and efficiencies of scale will generally benefit higher assessed companies more significantly. With higher levels of surplus, higher-assessed companies can use their economies of scale and excess surplus to create efficiencies and keep operating expenses at a lower level than would lower-assessed companies.

Furthermore, the benefits of these lower expense ratio efficiencies flow through to product pricing, where higher-assessed companies can usually offer more competitive rates, which may result in marginally higher profit margins. More significant innovation efforts can further help maintain and gain competitive advantages. Each line of business and state has its own unique operating environment, such that additional or tighter regulations may lead to varying results and distribution of operating performance assessments