Moody’s Investor Service (Moody’s) outlook for life insurers in 2013 is negative due to the continuous low interest rate environment and anemic economic growth.
Interest rates — both in the U.S. and around the world — will remain historically low for near future. Life insurers have, for the most part, been able to insulate themselves from the immediate adverse effects of the low interest rate environment because their investment portfolios turn over slowly and their management teams have taken action in the form of lowering crediting rates which have helped maintain interest margins.
Moody’s warns that these precautionary and self-preserving actions are short-lived and by the middle of the decade, earnings will increasingly become lower due to the low interest rate environment. The decline of investment return will begin to impact guaranteed contractual minimums and the ability of any of given insurer to lower its credit ratings and pass along the decreasing rates with their policyholders will evaporate.
Few life insurers have been able to properly hedge against the low interest rate environment because the hedging itself is rather expensive. Moody’s expects that those who have been able to afford will continue to do so and those who have been able to will realize adverse earnings.
In response to lowered earnings, many life insurers will chase higher investment yields by increasing asset and credit risk, which Moody’s views as a credit negative.
Although the low interest rate environment is a global issue, its effect will be felt more acutely in some places than others. Japan, for instance, has been operating in a low interest rate environment for 15 years and has learned to buttress itself and operate in this reality. European markets, which typically have higher quantities of guaranteed products with high guarantees, will be more quickly impacted.
Moody’s warns that due to the decreased purchasing power of consumers across the globe as a result of the recession, coupled with diminished returns due to the low interest rate environment, life insurers will begin to chase revenues in emerging markets. Moody’s views this expansion as a credit positive in the long term but a credit negative in the short term as bureaucratic and cultural hurdles will need to be overcome and the negative-to-neutral returns that accompany expanded operations in the short term.
Consumer’s decreased purchasing power and causes many households to postpone long-term investments in order to fund their immediate needs. The purchases that consumers will make in this economic milieu will be geared toward the shorter term. Banking products, for example will attract consumers at the expense of life insurers.
In response to the confluence of all of the aforementioned factors, life insurers across the globe will begin to shy away from providing long-term investment guarantees to their customers. Although insurers will develop and push guaranteed products that they feel they can handle in this environment, this overall trend reduces the attractiveness of the products offered resulting in constricted sales. Although, Moody’s cautions that the appropriate tweaks made to guaranteed products will improve the risk profile of the industry, albeit at a slow pace.
Moody’s also cautioned that a further weakening of sovereign credit in many European countries could have a significant impact on life insurers operations both directly and through their investment exposures.