Life and Annuity Issuers Face More Mortgage Pain: Analyst

The U.S. commercial real estate slump is causing more problems for life and annuity issuers’ investment portfolios, according to a new S&P Global Ratings market review.

Carmi Margalit, S&P Global’s life insurance sector lead, reported that 1.97% of the commercial mortgages in the portfolios have been extended for up to four years. The share of life insurers’ commercial mortgages extended is up from 1.06% in 2022 and up from just 0.43% in 2019.

The share of commercial mortgages in the portfolios that have been restructured increased to 0.21%, from 0.15% in 2022 and 0.11% in 2019.

Overall, when compared with what’s happening to banks’ commercial mortgage loans, “life insurers’ commercial mortgages are holding up well,” Margalit said.

But the Site Selection Group, a commercial real estate advisory firm, estimates that office building prices are already down about 15% to 20%. S&P Global analysts have estimated that a 20% office building price drop would have little or no impact on statutory surplus at the typical life insurer, but a 6.6% hit to statutory surplus at one insurer.

If office building prices fell 40%, that could cause a hit equal to 0.3% of statutory surplus at the typical life insurer but a 14% hit at one.

None of the insurers at risk were named.

What it means: Like individual clients, life insurers try to create diversified investment portfolios, and conditions that help some assets will hurt others.

The same increase in interest rates that’s pinching life insurers’ commercial mortgage loan investments is increasing the yields they earn on new bonds, helping them lock in the returns they need to offer life insurance policies and annuities with attractive benefit guarantees.

But advisors need to look carefully to see whether unusual problems are emerging at the insurers providing their clients’ life and annuity products.

The backdrop: Rating analysts, regulators and others have been watching the U.S. office market carefully for more than a year.

One issue is the effect of the COVID-19 pandemic-period remote work policies on companies’ use of office buildings.

Another is the effect of the increase in interest rates that began in 2022.

Many office building owners have used loans with relatively short terms to pay for the buildings. The owners have counted on being able to replace the old loans with new loans when the terms expire. But, because rates are now higher, the cost of refinancing the older mortgage loans has increased.

Some analysts have estimated that about half of the owners with mortgage terms expiring this year will get payment term extensions, make other special arrangements or go through foreclosure proceedings,

Life insurers v. banks: One factor helping life insurers get through the office building price slump is their conservative approach to mortgage loan underwriting, according to Margalit.

He points to S&P Global data showing that only 0.37% of life insurers’ commercial mortgages are at least 90 days delinquent or in foreclosure.

That’s up from 0.11% in 2022 and 0.3% in 2019.

But that compares with a 2022 commercial mortgage loan problem rate of 1.04% at banks and 3.25% at CMBS issuers.

Carmi Margalit. Credit: Allison Bell/ALM