Moody’s downgrades U.S. life insurance outlook to ‘negative’

The outlook for the U.S. life insurance sector has been changed from stable to negative, owing to the unprecedented economic turmoil from the coronavirus pandemic amid the decline in U.S. Treasury rates and a higher likelihood of a prolonged low rate environment, Moody’s Investors Service says in a new report released April 1.

U.S. life insurers have been significantly challenged by lower-for-longer interest rates, particularly at the long end of the curve, a credit negative for the sector.

“Over time, we expect much of the impact of low rates will affect insurers’ earnings and reduce interest-sensitive product earnings because of spread compression, which is prevalent in the already sizable blocks of the industry’s liabilities at minimum guaranteed rates,” Moody’s Vice President Manoj Jethani says. “There is also the risk of more sizable charges on a GAAP and statutory accounting basis, as insurers review the viability of their long-term interest rate assumptions.”

While interest rates have been relatively low for more than a decade, insurers have taken steps to manage the current environment, but earnings of interest-sensitive products through spread compression will continue to see further declines.

Moreover, an increase in defaults or a sharp drop in returns from alternative investments could also cause some insurers to reduce return assumptions.

Although capital is strong, a ratings migration could pressure capital this year. Life insurers match long-duration liabilities with similar duration investments, typically with a material allocation to corporate bonds. The severe economic shock across sectors, regions and markets could result in an uptick in rating downgrades and corporate bond defaults, which could weaken capital adequacy in 2020.

Here is a summary of underlying factors leading to the downgrade:

• Lower-for-longer interest rate environment is a significant challenge for US life insurers. Low interest rates, particularly at the long end of the curve, are credit negative
for the life insurance sector. Although widening corporate spreads provide some offset, the low interest rate environment will continue to reduce earnings of interest-sensitive products through spread compression, which is prevalent in the already sizable blocks of the industry’s liabilities at minimum guaranteed rates.
• Strong capital adequacy, although rating migration could reduce capital in 2020. Life insurers match their long-duration liabilities with a portfolio of long-duration investments, mostly corporate bonds. The severe and extensive credit shock across many sectors, regions and markets could cause a rise in rating downgrades and corporate bond defaults.
• Potential for significant losses from death benefits; life reinsurers at risk. Although not our expectation, a widespread coronavirus infection rate with a relatively high mortality rate for the insured population would cause death benefit claims to grow significantly for US insurers, especially those that take on a large amount of mortality risk.
• Decline in equity markets reduces earnings of numerous product types. Depressed equity markets will reduce earnings from numerous equity-sensitive products. That said, risk management in the life sector has significantly improved in the last decade, which will help mitigate the negative effects of volatility on variable annuity embedded guarantees, for example. However, these guarantees could prove costly to insurers in a prolonged low interest rate environment.

For more research and insight on the coronavirus (COVID-19) outbreak, please see moodys.com/coronavirus.