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Global Credit Research - 19 Aug 2011
New York, August 19, 2011 -- Moody's Investors Service today published a stress scenario analysis
demonstrating that a protracted period of low interest rates would subject
US life insurers to substantial losses and could result in rating downgrades.
The rating agency's baseline economic scenario for the United States
calls for a sluggish recovery, however, under which slowly
increasing interest rates would gradually relieve the spread compression
and earnings pressure insurers are currently experiencing.
The new report describes Moody's review of US life insurers'
2008--10 regulatory cash flow testing filings. "As expected,
our analysis showed that insurers fared badly under declining interest
rate scenarios," says Vice President Neil Strauss.
"Low interest rates over five or more years would lead not only
to significantly lower investment income, but also to higher reserve
requirements, weakening firms' profitability, capital
adequacy and financial flexibility."
"With the vast majority of total industry general account reserves
related to annuities and other interest-sensitive products,
US life insurers have a considerable amount of interest rate risk,"
Strauss says. "And a significant portion of their earnings
derive from interest spread." But because the crediting rates
paid to policyholders cannot be lowered below guaranteed minimums,
the profits companies earn from interest spread are compressed when interest
rates are low. Moreover, at some point investment yields
may fall below crediting rates, producing negative interest spread,
which hurts earnings significantly.
Currently, the 10-year US Treasury bond hovers just above
2%, which is extremely low on a historical basis and down
significantly from 3.3% at year-end 2010.
Life insurers' portfolios have on average been yielding between
5% and 6% for the past three years, generally heading
downwards as interest rates have declined. "Under our stress
scenario, in about five years the 10-year US Treasury rate
would be about 1.5% and the portfolio yield for insurers
would fall below 4.5%," Strauss says.
"And investment income would decline to a point where insurers may
be unable to both fund promised policy benefits and meet their profit
While life insurers are not expected to incur significant losses in the
near term, if interest rates were to remain at historical lows,
most affected would be firms with sizable exposure to fixed-rate
annuities, universal life policies with high crediting rates,
variable annuities with lifetime guaranteed income benefits, and
long-term care and disability.
Few insurers have bought protection against prolonged low interest rates,
Strauss says. Exceptions are the minority of companies that have
bought interest rate floors, and insurers with interest rate hedging
programs for variable annuity lifetime income guarantees or that have
locked in rates on the investment of future premiums.
The report is titled "Protracted Low Interest Rates Would Present
Major Risk for US Life Insurers" and is available on moodys.com.
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VP - Senior Credit Officer
Financial Institutions Group
Moody's Investors Service, Inc.
MD - Insurance
Financial Institutions Group
Moody's Investors Service, Inc.
Moody's Investors Service, Inc.
Moody's: US Life Insurers Would Be at Risk in Prolonged Low Interest Rate Environment
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