Life Insurers Facing Earnings Pressure From Low Yields
July 1, 2014 by Proquest LLC
US life insurers continue to face low bond yields and are likely to see earnings growth pressured over the next two years as a result, according to Fitch Ratings.
A sustained low-yield environment extending from today’s levels to beyond year-end 2015 would result in an increase in negative rating actions for firms exhibiting weaker earnings profiles and diminished reserve adequacy.
Fitch’s rate expectations recognize that rates should ultimately inch higher, which offsets low-yield concerns. Indicators of possible coming improvement in rates include the currently upward sloping yield curve, the Fed’s progress in withdrawing from quantitative easing, and our belief that modest tightening of monetary policy will occur by the end of 2015. Therefore, while the risk of muted yields remains likely, we believe that rates will be mostly an earnings headwind on life insurers over the near-to- medium term.
Our analysis of interest rate risk on life insurers, outlined in “Heightened Interest Rate Risk for U.S. Life Insurers” (July 2013) remains central to our views on rate sensitivities playing out through year-end 2016. The three cases we presented included a “good” scenario with a steady 100 bps rate increases per year, a “bad” scenario of level rates holding at year-end 2012 levels and an “ugly” scenario of a 500 bps spike upward.
The current track that we believe we are on today is only modestly better than the “bad” scenario. We see rates creeping upward slightly, but far below the 100 bps/year rate rise expectation of the “good” scenario.
Prolonged low interest rates result in poor reinvestment options and an excess of low-coupon bonds for life insurers, who tend to invest in long-duration assets. Insurers focusing on fixed- and variable-annuity products, long-term care and universal life tend to be more sensitive to interest rate risk. Spreads between investment returns and minimum rate guarantees (on products such as fixed annuities) will compress over time and the statutory reserve margin will deteriorate.
Further, sustained low interest rates increases concern about insurers overreaching for yield to mitigate spread compression. Fitch notes growing complacency in the bond market, which may lead to heightened investment losses in an adverse scenario.
For the typical life insurer, the impact of low interest rates rarely poses an immediate solvency concern, but the impact on earnings and statutory capital can be felt over time.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at fitchratings.com. All opinions expressed are those of Fitch Ratings.
Applicable Criteria and Related Research:
Heightened Interest Rate Risk for U.S. Life Insurers
http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=704570
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