Equity Analysts: Life Insurers Must Address ‘Perceptions of a Rising Interest Rate Environment’
July 22, 2014 by Fran Matso Lysiak
OLDWICK, N.J. – Policyholder behavior, as it is affected “by perceptions of a rising interest rate environment,” is a significant concern to equity analysts with Sandler O’Neill, a concern that life insurers must address, they wrote in a research note previewing second-quarter earnings for the industry.
Interest rates declined during the second quarter, the equity analysts wrote, adding that a rise in interest rates in 2014 would result in higher discount rates that could benefit free cash flows related to reserving and company pensions.
However, several products, for example, indexed annuities, allow for penalty-free withdrawals up to 10% of account values in any given year, the Sandler O’Neill analyst wrote. “If interest rates rise significantly in future periods, we have some concern that investors may take advantage of this benefit in order to pursue higher yielding financial products.”
“At the moment, we don’t believe the brief period of higher interest rates is sufficient to drive this particular policyholder behavior, but we will continue to monitor developments,” they wrote.
Fixed-income returns remain low, and the volatile equity markets of the recent economic crisis still are fresh in consumers’ minds but equity-indexed life and annuity products have been the one bright spot for the industry’s top line, according to a Best’s Special Report on the U.S. life/health industry published in the May 26, 2014 issue of Best’s Journal.
Sales of indexed annuities, for example, rose for the fifth consecutive year in 2013 and made up nearly 46% of all fixed annuity sales, according to the chief executive officer of Wink Inc., a firm that tracks the data. Total sales of indexed annuities in the United States last year rose to $36.8 billion, an increase of 13.4% from 2012. And 2013 represented the fifth straight year that sales have been up year over year, Sheryl J. Moore, president and CEO of Wink, said earlier this year.
With indexed annuities, an insurer invests most of the customer’s principal in bonds to ensure the policy will generate a small annual return but uses a small portion of the premium to buy options in a stock market index, usually the S&P 500. Options that are exercised can result in additional interest credited to a policy, potentially more than an investor might achieve through other fixed-income investments.
Meanwhile, unchanged from prior quarters, the primary concern investors continue to have for life insurers is the effects from low interest rates, the Sandler O’Neill analysts wrote, noting that yields declined in the second quarter. The 10-year Treasury yield at June 30 was 2.53%, down from 2.72% at the end of the first.
“We view the second-quarter interest rate decline as not unexpected but as an unfortunate consequence of the very slow improvement in the U.S. economy,” they wrote. Continued low interest rates will dampen investment income and profits from spread-based insurance products, they wrote.
New money yields will continue to be lower than the yields on the maturing investments as most life insurers have portfolio yields between 4% and 5%, they wrote. “We believe that crediting rates will lag the rise in the 10-year Treasury yield but there could be pressure on crediting rates in coming months should interest rates continue to rise.”
Meanwhile, a second area that “could pose a problem” for insurers is if policyholders begin to lapse in order to buy new policies with higher crediting rates, the Sandler O’Neill analysts wrote. A 30 basis point to 50 basis point “or even a 100 bps move in yields is not sufficient to drive this policyholder behavior.”
“In general, we view that 200 bps to 300 bps increase in yields could be a potential driver of lapses,” they wrote, but noting that rates don’t appear to be poised to rise in that manner, “so we view this as an outlying risk.”
(By Fran Matso Lysiak, senior associate editor, BestWeek: fran.lysiak@ambest.com)