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North American Life Insurer Credit Losses Will Remain Benign in 2025

    North American life insurer credit losses will remain benign in 2025, despite modest increases due to ongoing pressure on commercial real estate (CRE) assets, reflecting secular shifts and macroeconomic trends, according to Fitch Ratings report. Beinsure analyzed the report and highlighted the key points.

    Commercial real estate losses will continue to gradually emerge but are expected remain within ratings expectations relative to capital.

    Commercial real estate exposure, while significant, is diversified across property types, geographies and maturities, with performance supported by track records of strong performance through multiple cycles based on disciplined underwriting.

    Expected credit loss reserves related to commercial mortgage loans have gradually increased due to higher capitalization rates and lower occupancy rates for office properties.

    U.S. Life Insurers are Prepared for Lower Interest Rates

    U.S. Life Insurers are Prepared for Lower Interest Rates

    U.S. life insurers are prepared for lower interest rates, with stable earnings and capital that will remain within rating thresholds. U.S. life insurers, with their substantial fixed-income portfolios, stand to benefit from these dynamics, as well as alleviating the unrealized losses that have emerged post-pandemic with the Fed’s monetary tightening.

    Although portfolio yield growth for rated life insurers will slow with rate cuts, outcomes will depend on the yield curve’s shape and changes in credit spreads from their current, historically low levels.

    Fitch expects the federal funds target rate to decrease to 4.5% by year-end, drop to 3.5% by late 2025, and reach a neutral 3% by mid-2026.

    Despite recent rate hikes, levels remain relatively high compared to the past decade, supporting yields. New money rates continue to surpass portfolio yields for many insurers.

    The average 10-year Treasury rate was 4.27% in the 2024, compared with 3.96% for all of 2023.

    Commercial Mortgage Loans CECL Reserves

    Commercial Mortgage Loans CECL Reserves
    Source: Fitch Ratings, company financials

    Insurers with heavy office property exposure and near-term debt maturities face higher risk. Debt service coverage ratios should stabilize, but office properties remain under pressure.

    Loan-to-value ratios are near peak but may improve if cap rates fall. The NAIC credit quality of mortgage loans, which has declined, is expected to stabilize.

    Life insurers will keep increasing allocations to less-liquid assets, such as private credit, driven by partnerships with alternative investment managers. While private credit risk will rise slightly, insurers remain heavily invested in investment-grade, fixed-income securities.

    Commercial Mortgage Loans Asset Quality

    Commercial Mortgage Loans Asset Quality
    Source: Fitch Ratings, statutory financials

    Leveraged loans will remain under pressure from high interest rates but are expected to withstand broader economic challenges. Fitch will monitor the performance of less-liquid and complex investments during market downturns.

    Profitability should remain stable in 2025. While policy rates may drop further, alternative investment returns could improve, balancing slower growth in base portfolio yields. Strong balance sheets should help offset potential risks from economic and geopolitical uncertainty.

    Top-line growth and institutional sales volumes have been strong, with record levels of fixed annuity sales. Sales volumes will remain robust, but see some slowdown in 2025, driven by expected declines in credited rates.

    Favorably, this should result in improved policyholder persistency YoY.

    Total annuity insurance sales in the U.S. reached $114.6 bn in the third quarter of 2024, marking a 29% year-over-year increase. This represents the 16th straight quarter of growth, just below the record set in Q4 2023, based on data from LIMRA‘s U.S. Individual Annuity Sales Survey.

    Registered index-linked annuity (RILA) sales reached $17.3 bn in Q3 2024, a 37% increase year-over-year and the sixth consecutive record quarter. YTD, RILA sales rose 40% to $48.2 bn.

    “Since early 2024, numerous carriers have launched new RILA products or improved existing ones to meet high investor demand,” Hodgens stated. “LIMRA forecasts another record-breaking year for RILA sales in 2024, with continued growth into 2025.”

    U.S. Life Insurers’ Growth in Offshore Reinsurance

    The trend of U.S. life insurers partnering with alternative investment managers (AIM) via offshore sidecars and reinsurance platforms will persist, with positive and negative credit implications for rated issuers, Fitch Ratings says.

    Tie-ups will continue to take other forms, including minority stakes, but we expect an increased volume of offshore reinsurance vehicles, given investor appetite for the segmented risk, fee-based income, and capital optimization for the insurer.

    Offshore reinsurance vehicles can provide additional risk capital, which can allow insurers to originate and/or acquire larger volumes of business while helping to manage their capital requirements more efficiently and potentially improve financial leverage.

    The vehicles can also increase underwriting capacity and improve diversification by enabling insurers to share risks with investors, potentially reducing the overall risk exposure. Additionally, the vehicle can enhance earnings, with some sponsoring insurers looking to manage a proportion of investments.

    However, insurers may establish sidecars to drive above-average growth. These vehicles also introduce counterparty credit risk and potential regulatory scrutiny, which could negatively affect an insurer’s financial stability if the vehicle underperforms. Offshore structures can also increase compliance costs while raising operational complexities, which could pressure profitability and investment returns.

    Life and Annuity Offshore Sidecars

    SponsorReinsurance SidecarRisk Exposure
    MetLife/General AtlanticChariot Re Ltd.Life and annuity
    AllianzSconset Re Ltd.Life and annuity
    Third Point LLCMalibu Life Reinsurance SPCLife and annuity
    RGA/Golub CapitalRuby ReLife and annuity
    Athene / ApolloACRA 2Life and annuity
    Prudential / Warburg PincusPrismic Life ReLife and annuity
    Global Atlantic / KKRIvy Re IILife and annuity
    Kuvare/Davidson KempnerKindley ReLife and annuity
    American Equity Investment Life HoldCo.AEL Bermuda ReLife and annuity
    Massachusetts Mutual, Centerbridge PartnersMartello ReLife insurance
    Security Benefit / EldridgeSkyRidge ReLife and annuity
    Global Atlantic / KKRIvy ReLine-specific business
    Athene / ApolloACRALife insurance
    SCORAtlas Reinsurance X Ltd.Life and annuity
    Source: Fitch Ratings, Artemis.

    Insurers typically form sidecars to partner with external capital sources or to establish a structure to accept capital from third-party investors.

    While sidecars assume all of their business from the sponsoring insurer, reinsurance platforms originate through cessions from their sponsor, and are expected to assume third party business over time.

    Both types of offshore reinsurance vehicles are intended to optimize capital for the insurer, as well as increase fee income for the insurer and the AIM partner.

    Sidecars allow investors to participate in the risk and return of a specific group of policies. These may have a limited life and seek to leverage the insurers’ core competencies, including underwriting expertise. Sidecar structures may vary, with some sponsoring insurers retaining an equity stake while others do not.

    FAQ

    How will commercial real estate (CRE) losses impact insurers in 2025?

    Commercial real estate losses will continue to emerge gradually but are expected to remain within ratings expectations. Insurers’ CRE exposure is diversified across property types, geographies, and maturities, which helps mitigate risks. Strong underwriting practices and historical performance through multiple cycles also support portfolio stability.

    Why are commercial mortgage loan credit loss reserves increasing?

    Expected credit loss reserves for commercial mortgage loans are rising due to higher capitalization rates and lower office property occupancy rates. These trends have led insurers to strengthen reserves to account for potential future losses, particularly in office properties with near-term debt maturities.

    How prepared are U.S. life insurers for declining interest rates?

    U.S. life insurers are well-prepared for lower interest rates. Their stable earnings and strong capital levels remain within rating thresholds. Insurers benefit from substantial fixed-income portfolios and are likely to see relief from unrealized losses that emerged due to the Federal Reserve’s post-pandemic monetary tightening.

    What is the outlook for portfolio yields and the federal funds rate?

    Fitch expects portfolio yield growth for life insurers to slow as interest rates decline. The federal funds target rate is forecasted to drop to 4.5% by the end of 2025 and stabilize at 3% by mid-2026. However, new money rates continue to exceed portfolio yields, helping to maintain profitability despite slowing yield growth.

    How are life insurers managing investment risks in commercial mortgage loans?

    Insurers are gradually increasing allocations to less-liquid assets, including private credit, through partnerships with alternative investment managers. While this raises investment risk slightly, insurers maintain a strong focus on investment-grade, fixed-income securities to balance risk. Loan-to-value ratios for commercial properties are near peak levels but could improve if cap rates decline.

    What trends are driving growth in the annuity insurance market?

    Annuity insurance sales in the U.S. reached $114.6 bn in Q3 2024, marking a 29% YoY increase. Registered index-linked annuity (RILA) sales hit $17.3 bn in Q3, up 37% YoY. High investor demand has prompted insurers to launch new RILA products and improve existing ones. LIMRA forecasts record-breaking RILA sales in 2024, with continued growth into 2025.

    What challenges do insurers face with leveraged loans and other less-liquid assets?

    Leveraged loans remain under pressure due to high interest rates but are expected to withstand broader economic challenges. Fitch will closely monitor the performance of less-liquid, less-transparent investments during credit market downturns. Despite these risks, profitability is expected to remain stable in 2025, supported by strong balance sheets and potential improvement in alternative investment returns.

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    AUTHORS: Jamie Tucker, CPA, CFA – Senior Director, Life Insurance Fitch Ratings, Laura Kaster, CFA – Senior Director, Fitch Wire (North and South American Financial Institutions)