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.
