Strong growth of life product sales expected

Katharine Wolchik, a managing economist and head of global economics at AIG. Katharine Wolchik, a managing economist and head of global economics at AIG.

On the opening day of this year's Association for Advanced Life Underwriting annual meeting in Washington, D.C., National Underwriter Senior Editor Warren S. Hersch interviewed Katharine Wolchik, a managing economist and head of global economics at New York-based American International Group. The following are excerpts.

Hersch: What is AIG's growth forecast for the world economy in the near-term?

Wolchik: Despite recent challenges to the U.S. and world economies, including the fiscal cliff, the sticky unemployment rate and debt sovereignty crises in the Eurozone – including Italy, Spain and Cyprus – we expect growth for the balance of 2013 and 2014, including in the U.S. and the Eurozone. A main driver of growth in the U.S. will be residential investment – a key component of gross domestic product – which will dominate the headlines and numbers. We also expect that excess slack in the economy, or one that is performing below potential GDP, will help cap inflation at about 2 percent.

We also anticipate through 2017 an expansion of emerging markets, which will be the main engine of growth globally. There will also be more quantitative easing, both here in the U.S. and in Europe, but you'll see less system retrenchment than in the past. The Eurozone will stay together in its entirety; don't expect Greece, Italy or Spain to leave the Eurozone anytime soon.

Unfortunately, the low interest rate environment is here for the near-term, based on our forecast of economic growth and the unemployment rate. The earliest we have interest rates increasing is in 2015. As for the U.S. housing, we expect the market's recovery to be slow.

Hersch: What does AIG forecast for the U.S. life insurance market?

Wolchik: The U.S. is underinsured: Only 44 percent of U.S. households now have life insurance. Thirty percent of households – 35 million – have no life insurance coverage. This is up from 22 percent in 2004. And 11 million households with children under 18 have no life insurance. A big contributing factor is folks in the middle and lower-income classes, who are very stretched right now.

Hersch: What trends has AIG observed in respect to life real premium growth since 2011?

Wolchik: World life insurance direct premiums have declined by 2.7 percent in real terms since 2011. Both advanced and developing economies had negative growth rates: Advance economies contracted by 2.3 percent, whereas emerging markets shrank by 5.1 percent.

Much of the decline in advanced economies can be attributed to Western Europe, including Germany, France, Italy and the U.K, which saw their economies dip by 7.1 percent, 15.6 percent, 20.2 percent and 3.3 percent, respectively.

We expect that the downward trend observed in 2012 will continue through 2013. On a positive note, we expect the 2.3 percent rebound in the U.S. since 2011 will also continue in tandem with the uptick in the economy.

As to emerging markets, the 5.1 negative growth can be attributed to real premium slides in the Southeast, which fell 10.4 percent; as well as shrinkage in China and India, which were off by 14.8 percent and 8.5, respectively. These two countries, both large components of the emerging markets, saw regulatory changes that negatively impacted distribution.

However, Latin America's market rose 9.5 percent, fueled in large measure by Brazil's expansion (up 10.2 percent) and Mexico (up 7.2 percent). The Middle East and Central Asia also saw gains, rising 9.4 percent, as did Africa, up 1.3 percent.

Hersch: Which products are contributing most to premium growth trends in the U.S. and Europe?

Wolchik: A large component of the market is savings or risk premiums, which are being driven by growth in annuities and pensions. This makes sense, given the aging populations of the U.S. and Europe, which boost consumers' need for these products.

Hersch: Can you speak to the headwinds and tailwinds affecting life insurance sales?

Wolchik: In respect to headwinds, premium growth is slow in the U.S. and Canada; and it's negative in Europe. The global recovery remains fragile. The low interest rate environment will remain challenging, as will Eurozone risk and macroeconomic and financial volatility.

As to tailwinds, we're looking at strong growth in emerging markets in both 2012 and 2013, fueled by premiums gains in China and India. Overall, AIG's outlook for the life insurance market remains stable, taking into account  both downside risk in the developed markets and positive potential in emerging markets.

Hersch: Which life insurance products and risk are most affected by trends in the global economy?

Wolchik: Accumulation vehicles – whole life, universal life, variable life, VUL and endowment products – will be sensitive to continuing low interest rates and equity market trends. The same applies to savings vehicles, including deferred fixed, unit-linked, guaranteed and defined benefit products.  Protection products, including term life, group life, disability income, long-term care and payout/impaired annuities, will remain prone to fluctuations in mortality, morbidity, longevity and lapse rates.

We've observed also a downward trend in sovereign yields in developed markets since 2000; the trend line has been more pronounced since the global economic crisis of 2008.

Hersch: What are the implications of the low interest environment going forward?

Wolchik: Lapse rates will rise as the macroeconomic environment deteriorates. The increasing lapse rates will dampen premium growth. Low interest rates will make insurance products more expensive, which in turn will depress demand. Low interest rates will also depress insurers' investment returns, resulting in weakened profitability and weaker stock prices.

Hersch: What demographic trends are impacting life insurance sales and economic growth trends?

Wolchik: Most of the population growth we see is happening in Asia, Latin America, Africa and Oceania. We forecast a population decline in Europe through 2050 and flat or stagnating growth in the U.S. over the same period. In Europe and North America, we also expect an aging population through 2020, given the rising percentage of people on these continents over age 70.

The demographic trends are impacting real capital stock growth. The G-7 economies – the U.S., Canada, Japan, Germany, France, the U.K. and Italy – will see little growth through 2015, with rates varying between 0.01 and 0.07 through 2015. In contrast, non-G-7 Euro countries – among them Russia, Brazil, Australia, Mexico, India, China, South Korea and Spain – will enjoy real capital stock growth of 4 percent or greater over the same period.

Hersch: How will the various trends you just outlined impact the developed world?

Wolchik: The aging population, slower pace of capital stock growth and a continuing deleveraging in the banking and consumer sectors will translate to lower potential private sector growth, both in the short-term and in the medium-term.

The former economic power houses of the world, the G-7 economies, are expected to have negative or slow growth rates in 2013. And more of the same can be expected in 2014, with GDP growth rates varying from 0.34 percent to 2.83 percent.

The non-G-7 countries of Europe will perform somewhat better. But Asia will see the greatest expansion through 2014, with growth rates in most countries forecasted that year to exceed 5 percent. This region has all the ingredients to keep the global economy going.

Hersch: What does AIG forecast for U.S. life insurance product sales?

Wolchik: We forecast slow growth for these products in 2012 – we have actual growth numbers only through 2011 – because the economy did not perform as well as we expected. Except for term life, we expect growth across products in 2013, with rates varying between 3.7 percent for variable life and 7.20 percent for whole life. In 2014, growth rates will be solid for all products; universal life and variable life/VUL will enjoy rates ranging from 7.7 percent to 10.1 percent.

Hersch: And what does AIG forecast for the unemployment rate and nonfarm payroll employment?

Wolchik: We expect the unemployment rate to dip to below 6.5 percent in 2016, the decline happening in tandem with a pick-up in interest rates. Nonfarm payroll employment will rise from 130 million-plus to nearly 145 million over the same period. If this were a normal business cycle, we would have hit 6.5 percent one year ago. Nonetheless, employment is moving in the right direction. Job creation is happening across sectors, including construction, manufacturing, education and health services. By region, most of the job creation is happening in the south: Between December of 2011 and December of 2012, job creation in the region consistently exceeded 1.3 million on a month-to-month basis.

Hersch: You indicated earlier that we should expect further quantitative easing near-term? What are you forecasting?

Wolchik: We have marked down our QE3 expectations, but continue to anticipate no funds rate hikes until the second half of 2015. We now assume that QE3 will continue only through the end of this year, rather than the first quarter of 2014.

Our new QE call reflects, in part, our reassessment of FOMC (federal open market committee) views on the costs and assessments of further asset purchases.

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