Improving economy to fuel gains for life insurers

"Although recent global growth jitters have generated higher price volatility in October and November, we expect US equity market prices to continue to progress in 2015, albeit at a slowing pace, providing healthy fee-based income again in 2015," Moody's states. "However, VA hedge 'noise' — from derivative-based accounting mismatches, hedge inefficiency, etc. — will keep earnings, as well as VA reserves and regulatory capital, volatile."

The Moody's brief indicates that equity-sensitive and AUM-driven fee-based businesses have been a small proportion of revenue: 4 percent of statutory revenues in 2013 and through the first half of 2014. They have, however, been a growing source of industry revenues and earnings.

Moody's expects this trend to continue next year, reflecting the industry's greater focus on less capital-intensive products. Exhibits 2 and 3 below show the growth of statutory fee income and the composition of industry statutory revenues, respectively.

In response to continuing improvement of the nation's economy — as reflected in reduced unemployment, low inflation and rising gross domestic product — the Fed discontinued its bond-buying program on October 31. During a September meeting, a majority of Federal Reserve Open Market Committee members cautiously agreed that 2015 would be the "appropriate timing of policy-firming." Translation: a short-term federal funds rate rising in tandem with the continuing economic recovery.

Exhibit 4 below show interest rates for U.S. Treasury notes over a 60-year period. Exhibit 5 forecasts a continuing, steady rise in interest rates for these notes through 2018.

"With so much of life insurers' business sensitive to interest rate fluctuations — from investments and liabilities, to insurance products and sales — next year's expected gradual rise in interest rates cannot come soon enough," the report states. "A gentle rise in interest rates next year means life insurers will be able to offer incrementally higher crediting rates (and/or increase their crediting rate margins) as yields on new investments rise. This will help them manage the persistency on in-force policies, while also attracting new sales."

Moody's cautions that the rising stock market valuations and improved employment picture of recent months have to be weighed against historically low economic growth numbers. GDP is expected to top out 2.2 percent and 3 percent, respectively, in 2014 and 2015. These growth rates will nonetheless be sufficient to bring unemployment down to below 6 percent next year. (See exhibits 6 and 7).

"Although there are some downside risks, none is significant enough to likely knock continuing favorable economic developments off their track in the US," the report states. "Nonetheless, the sources of risk are the following: (1) a sharper, more protracted economic downturn in China than expected, due to a steeper downturn in the property sector than assumed (the global economy would be affected by trading ties and a loss of confidence for investors); and (2) a broad-based market correction, triggered by concerns over a rise in interest rates in the US, causing sharp global market volatility that results in a loss in household and economic wealth.

"However, only a sharp, prolonged, and widespread market correction, with significant losses for banks, would have a visible effect on the global economy," Moody's adds.