Although the US life insurance
industry experienced a rebound in statutory profits in 2009 this
does not spell a complete end to its problems, Moody’s highlights
in a study of prospects for 2010. Still plaguing the industry are
lower revenues, weak net investment income and lurking danger from
variable annuities.


After sustaining a total statutory
net loss of $50bn in 2008, the US life insurance industry turned
the corner in 2009, generating statutory net income of about $10bn
in the first three quarters of 2009, according to Moody’s Investors
. Despite this turnaround, Laura Bazer, a vice-president
and senior credit officer at the ratings agency, predicts there
will be no quick return to normalised profit levels.

“Although we see a general
improvement in the industry’s operating earnings, we believe
specific life insurance companies are at various stages of recovery
and a full restoration to normalised earnings will likely be a slow
and uneven process,” said Bazer.

“The pressure points on revenues
and earnings in 2010 are likely to be similar to those in 2009,”
she added.

In particular, the life industry
faces revenue pressure reflected in statutory revenues including
net investment income, which in the first nine months of 2009 fell
14 percent compared with the same period in 2008.

Bazer anticipates that pressure on
revenues will continue in 2010 for a number of reasons, not least
being a weak economy, high unemployment and volatile equity markets
which are lowering demand for many insurance products.

“Variable life, universal life
insurance, variable annuities, and, more recently, fixed annuities
have all been swept into the financial maelstrom during recent
quarters, and most of these products had double-digit sales
declines in 2009,” she said.

In total, statutory premiums and
deposits in the first nine months of 2009 were down 13% compared
with the same period in 2008. Also curbing revenue growth are
weaker net pension plan deposits, weak group benefit enrollment and
poor case persistency, noted Bazer.

Weak investment

Insurers can also expect little joy
from net investment income in 2010, predicts Bazer. Combining to
depress net investment income are high levels of low-returning cash
and short-term investments in insurers’ portfolios, lower
investment returns on alternative investment classes such as
private equity and hedge funds, and asset defaults.

From an asset default perspective,
the first wave of losses was driven by a collapse of the
residential property market which devastated the values of subprime
and Alt-A structured securities as well as the value of investments
in other housing-related assets.

Bazer explained that while most
life insurers have written down substantial portions of their
housing-related assets over the past six quarters, the commercial
property sector has emerged as a new problem. Life insurers’
commercial property performance has started deteriorating, with
delinquencies, foreclosures, impairments, and valuation allowances
all rising.

Indicative of the deterioration,
the life industry’s statutory commercial mortgage impairments rose
from about $300m in the first quarter of 2009 to about $600m in the
third quarter. Bazer said that Moody’s expects the life industry’s
aggregate loss on commercial mortgage loans (CML) and commercial
mortgage-backed securities (CMBS) to be about $10bn, most of which
will be reported in 2010 and 2011. Under its stress test scenario,
the aggregate loss could be as high as $43bn.

On a positive note, Bazer said
total CML and CMBS expected losses should be manageable and would
be unlikely to prompt downgrades.

Variable annuity

Big players in the variable annuity
(VA) market were especially hard-hit by the financial crisis, which
sent the S&P 500 (equity) Index tumbling from a peak of 1,400
in May 2008 to a low of 670 in March 2009. In the process, average
VA assets under management fell sharply, in turn hitting fees

But, stressed Bazer, more damaging
for large VA providers were rising reserve requirements to support
guaranteed benefits, rising hedging costs and write-downs of
deferred acquisition costs (DAC) and intangibles. She added that
these all contributed to large operating losses and lower
regulatory capital levels.

She added that during 2009, VA
producers had to prepare for complex new VA reserve requirements
before they became effective at the end of 2009. Concurrently, VA
sales were under pressure, dropping 23% in the first nine months of
2009 compared with the same period of 2008.

The equity market recovery since
March 2009 – which has seen the S&P 500 Index recoup about 60%
of its decline of the preceding 15 months – reversed some of the
damage to earnings and surplus, noted Bazer. After the first
quarter of 2009, VA reserve releases and positive DAC adjustments
“significantly buoyed VA earnings,” Bazer said.

However, she noted that the benefit
of the equity market recovery was somewhat muted by the costs
and/or the losses associated with hedging programmes that many
insurers put in place in the first half of 2009 to protect
statutory capital against further equity market declines.

Longer-term risks faced by
providers of VAs and other equity-sensitive products have only
recently begun to be addressed with the launch of new products
offering less generous benefits. For example, new products have
less aggressive guarantees and fewer fund offerings, all for a
higher cost.

Insurers have also tried to make
products simpler and easier to hedge, said Bazer. In addition,
hedge programmes have been expanded, added, and/or redesigned to
manage more than just GAAP (Generally Accepted Accounting
Principles) earnings volatility, and more off-shore captive
reinsurance has been utilised.

However, while insurers have acted
to reduce risk exposure, large blocks of old-style VA liabilities
sold at the height of the market are still in force and remain
in-the-money. In essence, the guaranteed amounts exceed the
contract values.

Bazer said that though insurers
have added new hedges to reduce risk exposure to old-style VA
liabilities, efficacy of these hedges over the long-term under
various equity market and policyholder behaviour scenarios is
uncertain. Specifically, old-style VA contracts would become a
problem if the equity market fell dramatically and/or policyholder
behaviour became what Bazer termed “more efficient.”

Unsurprisingly Moody’s has retained its negative outlook for the
US life industry. Rating outlooks for 40% of all life US insurers’
remain negative.