Signs that a period of ultra-low interest rates may be coming to an end has stirred optimism that revenues, profitability, employment and stock prices of insurers will skyrocket, with agents – as well as mutual insurance companies – benefitting. In its outlook for the life insurance industry for 2014, released in early January, Standard & Poor’s Ratings Service said that low interest rates “remain the primary impediment” to life insurers' earnings and “appear poised to increase.” The reality, however, is far more nuanced.
Many forecasts within the industry predict a gradual growth – instead of a return to pre-2008 levels – for at least three years. That’s because general fund book-yields will continue to decrease during that period, even though interest rates are projected to slowly rise.
Moreover, analysts say that growth will vary by the products sold. Besides the slowly improving economy and gradually increasing interest rates, insurers should also benefit from greater sales and margins on products, as well as greater fee income from 401(k) and defined benefit plans they administer that are being helped by a strong stock market.
At the same time, recent trends make clear that one boost for insurers going forward will be greater interest in their products as rising interest rates allow the industry to compete more effectively with broker-dealers, banks and mutual funds.
Fixed annuities are already seeing a boost, and there is optimism that interest in variable annuities, another key product and a profitable one in the past, will resume a growth path once insurers have the flexibility to offer more attractive guarantee riders on this key product.
Not a cure-all
But all of this does not change the industry consensus that rising interest rates will not be a cure-all for insurer balance sheets. “There are a lot of moving parts here and it is likely to be several years before interest book-yields in general accounts increase,” said Terence Martin, director of insurance research at Conning. Therefore, growth for insurers across the board will be gradual, even as the economy grows and interest rates return to more normal levels.
“We see the industry improving gradually while still hindered by decreasing book yields even though interest rates are projected to slowly rise,” Martin said. That’s because higher-yielding investments in the portfolio are rolling off and being invested at lower rates than they were. “Conning’s forecast looks out three years and our forecast through 2015 doesn’t see a return to pre-2008 levels,” he said. This is consistent with the views of insurance companies, most of whom have adopted a stance of not forecasting or relying on possible future trends.
As Chris Blunt, co-president of the Insurance and Agency Group of New York Life, put it: "While gradually rising interest rates certainly lessen the pressure on life carriers, they do not eliminate it.”
Blunt said the rise in rates will have an immediate impact on the competitiveness of fixed deferred and income annuities relative to alternatives such as Certificates of Deposit. Also, as rates rise, bond funds will see declining Net Asset Values, “which will make the stability of products like whole life and income annuities that are much more attractive to consumers," he said.
Tom Dennis, a staff official at LIMRA’ Secure Retirement Institute (SRI), agrees. He said rising interest rates do not have a significant impact on an insurer’s institutional products. The only real impact is attributable to an insurer’s general account investment products, i.e., stable value. “Typically, stable value investments will experience more favorable returns than fixed income mutual funds in a rising rate environment,” Dennis said.
John Nadel, managing director, equity research at Sterne Agee & Leach in New York, said the move to long-term rates has “clearly been a positive” for the life insurance stocks as investors' fears of potential balance sheet-related charges (intangible impairments, increased reserve requirements, etc.) have eased.
“That is not to say that today's rate environment is ideal – long-term rates are still historically low and below current portfolio yields,” he said.
As such, Nadel said, “today's rate environment does still pose a headwind for the industry, but that headwind is far less severe than it was just six to seven months ago.”
Moreover, he said, consensus expectations are that long-term rates are likely to continue to increase over the next few years, which, all else equal, would likely be a positive for the industry.
“Looking out over the next few years, the headwind that exists today is expected to continue to ease,” Nadel said. “This, coupled with a strong equity market and improving overall economic outlook, has been a key driver for improved stock performance and valuations for the life insurers.”
The annuity angle
A recent report from LIMRA’s Secure Retirement Institute (SRI) states that fixed-rate deferred annuity sales increased 66 percent in the third quarter of 2013, compared with the third quarter 2012. Overall, total annuity sales for the quarter increased to $59.4 billion, a 9 percent increase — the largest year-over-year growth since the second quarter 2011. For the first nine months of 2013, total annuity sales were $167.6 billion.
“In addition to the substantial growth experienced by fixed-rate deferred annuities, indexed annuities grew 15 percent in the third quarter to hit a new peak of $10 billion,” said Joseph Montminy, assistant vice president, annuity research, at LIMRA’s SRI. “This growth was driven by improvements in the interest rate environment, increasing demand for accumulation-type annuity products."
Total fixed annuity sales improved 31 percent in the third quarter of 2013 over the prior year to reach $23.5 billion — a level they have not reached since the third quarter 2009. Year-to-date, fixed annuity sales rose 6 percent, totaling $58.0 billion.
Todd Giesing, a staff official at LIMRA’s SRI unit, said that, since fixed-rate deferred annuities are purchased for principal protection and growth, the rise in interest rates was the main factor in the 66 percent increase in fixed-rate deferred annuity sales in the third quarter of 2013.
At the same time, variable annuity (VA) sales for that same quarter dropped two percent compared to the prior year, despite the fact that, in 2013, the U.S. stock market performed at its highest level since 1995. Giesing said the reason we did not see variable annuity sales increase in the third quarter, despite the fact that equity prices soared, is that some top variable annuity companies are carefully managing sales. However, LIMRA SRI is forecasting a slight growth in VA sales for 2014, he said.
Cathy Weatherford, president and CEO of the Insured Retirement Institute, said interest rates during most of 2013 had a positive impact on the insured retirement marketplace.
For immediate and deferred income annuities, there were higher payout rates. And fixed deferred annuities offered higher crediting rates, while fixed indexed annuity caps and participation rate increased. “As a result of these changes, sales stabilized during 2013,” she said.
At the same time, demand for retirement income products continues. “We project that this demand, along with the continual rise in interest rates at a manageable pace, will lead to strong annuity sales in the quarters ahead,” Weatherford said.
John McCarthy, product manager, insurance solutions, at Morningstar, attributes the decline in VA sales – despite the strong stock market – to a variety of factors. Morningstar calculations show a minimum of 80 percent of VA offerings contain living benefit riders. Insurers have been handicapped at offering attractive rates on these riders because of the persistent period of low interest rates.
Insurers began offering guaranty riders on VAs in the 2002-2004 period, when the stock market was in the doldrums, as a means of enticing consumers to purchase VAs, a highly profitable product whose sales soared in the 1990s. The peak for VA sales with guarantees was 2007, when sales soared to $179 billion. But it has been downhill since because of the recession, even though sales started to rebound a few years back.
“Despite the 2011 rebound, sales have never reached the peak of 2007,” McCarthy said.
Part of that stems from the fact that small investors seeking to benefit from both the rising stock market and the tax advantages of buying VAs, “are always behind the curve,” as McCarthy put it. They get involved in rising stock markets long after institutional investors do so, and also cease purchasing such products long after institutional investors, who benefit from having access to expensive research, which provides them with quick insight into emerging trends. Like Geising, McCarthy sees VA sales rising as interest rates rise, which allows underwriters to provide higher crediting rates on guarantees. IRI’s Weatherford said that VA sales will rise due to a decrease in costs for insurers to hedge living benefit riders, and a decrease in reserve requirements for living benefit riders.
As for indexed annuities, LIMRA’s Giesing said the product provides “valuable solutions” for protected growth. Many consumers also look at indexed annuities for guaranteed lifetime income options. “We are seeing more and more acceptance of indexed annuities in the market from both consumers and advisors,” Giesing said.
Sales of index annuities, which are dominated by independent agents, have been expanding into other distribution channels, particularly banks. “Index annuity crediting rates are also impacted by interest rates, and the rising interest rate environment is helping index annuity sales,” Giesing said.
He added that distribution of indexed annuities and variable annuities is quite different and indexed annuity sales do not appear to be materially affecting VA sales at this time.
Sean Dargin, a vice president at Macquarie Securities Group, said that the VA has really concentrated in a few players the last few years as insurers de-risked their product offerings, but says the larger players, such as Prudential Financial, AIG and Lincoln Financial, should benefit as rising interest rates help insurers compete.
A return to a more normal interest rate environment is critical in the short term to the strong growth of insurers and their ability to compete against other financial services providers such as banks, brokerages, and such asset managers as mutual funds, Pimco and BlackRock. Over the years, low interest rates have hurt the ability of insurers to sell their most profitable products, such as fixed and variable annuities, and such staples as life insurance and variable life insurance.
However, the long-term trend is that mutual funds and other asset managers are growing their assets faster than insurers. “For two or three decades, insurers have been losing market share to asset managers,” Dargin noted.
A benefit to insurers as they seek to compete in the financial services marketplace is that they have the ability to make lifetime income guarantees. The challenge will be to get asset managers to hand over their assets to life insurers. That is a long-term, but growing issue. As Dargin noted, “They will have to do that to sustain their business.”
What a difference a quarter makes in annuity sales results. In the 2013 third quarter, total fixed annuity sales were up 31 percent over third last year, according to LIMRA's new estimated results. Indexed annuities were up by 15 percent and produced a quarterly sales record of $10 billion and a $1 billion increase from second quarter.
The indexed annuity performance is illuminating from a number of perspectives. For one thing, most of the increase came from accumulation-type products, according to LIMRA. We are seeing broader acceptance of indexed annuities across the different distribution channels. In addition, all of the other fixed sales components were up. Here are a few pieces of that story, based on year-over-year third quarter estimates reported by LIMRA:
- Market value adjusted annuities were up 110 percent for the quarter.
- Deferred income annuity sales – still considered a relative newbie in the annuity world – were up 106 percent.
- Fixed-rate deferred annuities were up 66 percent.
- Book value annuities were up 56 percent.
- Fixed deferred annuities were up 35 percent.
- Indexed annuities were up 15 percent.
- Source: LIMRA, “Fixed Annuities Were ‘The” Sales Story in 3Q”