The Best’s Special Report, “U.S. Life/Annuity Industry Core Earnings Remain Profitable as Companies Look to Sustain Yields,” notes that overall industry results benefited significantly from a large $8.0 billion statutory gain for American International Group Inc.’s AGC Life Insurance Company subsidiary. The gain was due mainly to a one-time reserve reinsurance transaction with Hannover Life Reassurance Company of America, which ceded approximately $14 billion of in-force reserves.

According to the report, a 3.2% rise in the broader stock market in fourth-quarter 2016 and 11.9% for the full year contributed to more favorable earnings, which nevertheless remain below historical levels despite a steady increase in invested assets and capital. Industry earnings continue to be dampened by a persistent low interest rate environment and the lack of substantial organic growth given the mature nature of the industry. Earnings from individual annuities business were strong, up 63% from 2015, due mainly to the Federal Reserve’s 25-basis-point interest rate increase during the fourth quarter and the decline in asset adequacy reserves.

The L/A industry’s net income declined approximately 12%, to $36.8 billion from $41.1 billion, owing to a large realized capital loss of around $12.5 billion. The capital loss was due mainly to the impact of derivatives hedges, which were hurt by rising equity indices and interest rate swaps resulting from declining long-term interest rates.

The industry’s largest investment allocation is still in bonds; however, bond holdings as a percentage of invested assets continue to decline, to 73.6% in 2016 from 74.6% in 2012, while less liquid mortgage loans increased to 11.2% of invested assets in 2016 from 9.8% in 2012.

The report states that low interest rates and equity volatility remain the industry’s largest fundamental headwinds, which not only lead to spread compression as a result of lower investment income but also can make it more difficult for direct writers and agents to sell products with less attractive features. A.M. Best believes that the most beneficial environment for earnings improvement in the near term would be a slow, steady march northward in interest rates, as virtually all companies would realize an improvement in earnings as a result of higher rates. A.M. Best expects the life insurance market to expand in 2017 on the backs of higher interest rates and ongoing consumer interest in protection and accumulation products, tempered somewhat by regulatory uncertainty.

To access a copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=261540.

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