U.S. life insurers are prepared for lower interest rates, with stable earnings and capital that will remain within rating thresholds, according to Fitch Ratings report. Beinsure analyzed the report and highlighted the key points.
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.
The yield curve has steepened following the Fed’s 50bps rate cut, driven by disinflation, stronger-than-expected job reports, and reduced recession fears. Market volatility has risen in the second half of 2024 amid high U.S. equity market valuations.
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 first half of 2024, compared with 3.62% in the first half of 2023 and 3.96% for all of 2023.
Life Insurance Market Historical Margins
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.
Strong economic conditions and demand for guaranteed retirement income continue to drive robust annuity sales.
Even with the potential for further rate cuts, LIMRA expects fixed annuity products to surpass previous sales, setting new records in 2024. In the first three quarters of 2024, total annuity sales rose 23%, totaling $331.2 bn.
Life insurance growth and institutional sales volumes
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.
Earnings for Fitch-rated peers are well diversified, and while alternative investment income has been largely below long-term return expectations YTD, fee-based income has benefitted from favorable equity markets and claims experience has been favorable with more normalized mortality.
Lower rates are a potential positive for asset management flows, specifically fixed-income strategies. Quantitative tightening, lower interest rates and reduced liquidity can create a favorable environment for fixed-income strategies by enhancing yields, improving portfolio values, and attracting more investment flows.
U.S. life insurers stand to benefit
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.
Interest rate declines will lead to higher bond values and shareholders’ equity, assets under management and fee income.
Before the Fed’s tightening cycle began in 2022, insurers tackled falling portfolio yields by shifting investments. They focused heavily on private bonds and, to a lesser extent, lower-rated bonds, predominantly ‘BBB’ rated.
Additionally, they reduced sales of interest-sensitive products, like variable annuities with guaranteed living benefits and guaranteed universal life insurance. Despite rising interest rates, these trends have continued and are expected to persist through 2025, according to Fitch.
Fitch Ratings expect weaker asset quality to emerge in private credit assets, but do not expect US life insurers to face widespread pressure on ratings, as most exposures remain small relative to other asset classes, mitigating downside risk.
Most life insurers continue to return capital in normal course, and we don’t foresee meaningful credit impacts yet.
Most of the leading US life insurers experienced a year-over-year drop in total revenues.
US life insurers are expected to report improving mortality results for the second quarter and field questions related to credit risk as concerns mount over the industry’s exposure to commercial real estate
U.S. Life Insurer Commercial Mortgages by Type
While Fed rate cuts have somewhat eased the pressure on commercial real estate (CRE) valuations, many properties, especially office spaces, still face significant challenges. Losses in this area are set to grow throughout 2024 and beyond. However, U.S. life insurers are unlikely to see rating downgrades driven by CRE exposure.
The sector benefits from robust capitalization, conservative underwriting practices, and a strong history of weathering various economic cycles.
CRE exposure for U.S. life insurers consists of high-quality, well-diversified investment portfolios. These portfolios are managed with conservative underwriting standards, strong liquidity positions, and effective asset-liability management.
CRE investments represented about 15% of insurers’ assets, equivalent to 1.3 times capital. Roughly 75% of this exposure is in commercial mortgage loans, 25% in commercial mortgage-backed securities (CMBS), with the remainder in real estate equity.
FAQ
U.S. life insurers have stable earnings and strong capital positions that remain within rating thresholds. Fitch Ratings indicates that while portfolio yield growth may slow with rate cuts, the overall impact will depend on the yield curve’s shape and credit spread changes from current historically low levels.
The yield curve steepened following the Fed’s 50 basis point rate cut. Key factors include disinflation, stronger-than-expected job reports, and reduced fears of a recession. High U.S. equity market valuations have also driven market volatility in the second half of 2024.
Fitch expects the federal funds target rate to decrease to 4.5% by the end of 2024, drop further to 3.5% by late 2025, and settle at a neutral 3% by mid-2026. Despite recent rate hikes, current levels remain higher than those of the past decade, supporting yields.
Total annuity sales in the U.S. reached $114.6 bn in the third quarter of 2024, a 29% year-over-year increase. This marks 16 consecutive quarters of growth, driven by strong economic conditions and demand for guaranteed retirement income. LIMRA projects fixed annuity sales to continue breaking records despite rate cuts.
Earnings are well diversified across various sources. While alternative investment income has been lower than long-term return expectations, fee-based income has benefitted from favorable equity markets. Additionally, normalized mortality rates have contributed positively to claims experience.
U.S. life insurers have significant exposure to commercial real estate (CRE), which accounts for about 15% of invested assets. However, Fitch notes that insurers are well-positioned due to robust capitalization, conservative underwriting, and effective asset-liability management. The sector is unlikely to face widespread rating downgrades from CRE exposure.
Insurers have maintained diversified, high-quality investment portfolios with conservative strategies. Approximately 75% of CRE exposure is in commercial mortgage loans, 25% in CMBS, and the remainder in real estate equity. Insurers have also invested in private bonds and lower-rated bonds, particularly ‘BBB’ rated, to manage portfolio yield challenges.
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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)
