Standard & Poor's Credit Outlook on the U.S. Life Insurance Industry
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Standard & Poor's Credit Outlook on the U.S. Life Insurance Industry Matt Carroll, CFA Senior Director Carmi Margalit, CFA Director North American Insurance Ratings October 28, 2013 Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Copyright © 2013 by Standard & Poor’s Financial Services LLC. All rights reserved.
Agenda I. U.S. Life Industry Outlook & Recent Trends II. Life Insurers’ Sensitivity to Interest Rates III. Quick update on S&P Insurance Criteria 2
Sector Outlook & Recent Trends
S&P U.S. Life Insurance Sector Outlook: Stable
• Stable outlooks predominate
• Companies well positioned for the environment
• Strong balance sheets
• Focus shifting from spread to fee type businesses
• Modest use of yield enhancement strategies with
less-liquid and riskier assets
• Most are de-risking and/or re-pricing products post
crisis
• Legacy issues are being addressed
4Implied Investment Grade Corporate Bond
Yields
Source: Standard & Poor’s Ratings Services and Bloomberg
The investment portfolio yield for a typical insurer will generally
range between ‘BBB’ corporate bond yields and ‘A’ corporate
bond yields
5Life Bond Quality: Increase in ‘BBB’ exposure
Life Bonds: Quality
100.0%
3.1% 3.2% 3.7% 3.6% 3.5% 3.3% 3.4% 3.6% 4.0% 3.8%
95.0% 4.3% 4.1% 4.0% 4.4% 4.1% 4.3% 4.0%
5.0%
90.0%
85.0%
22.5% 22.8%
80.0%
24.6% 26.2% 25.0% 24.9% 26.0%
26.9% 28.1% 28.6% 27.0% 27.3% 28.4% 30.8%
28.3%
30.8% 28.7% 29.7%
75.0%
70.0%
65.0%
60.0%
55.0% 72.3% 72.0%
69.3%
66.2% 64.6% 64.3% 68.0% 69.3% 69.3% 67.6%
65.3% 65.5% 65.8% 65.0%
50.0% 61.7% 62.9% 62.9% 62.9%
45.0%
40.0%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
NAIC 1 NAIC 2 NAIC 3 NAIC 4 NAIC 5 NAIC 6
Source: Standard & Poor’s Ratings Services
6Life Industry Net Investment Yield (2007-2012)
8.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
2007 2008 2009 2010 2011 2012
Life Net Investment Yield Avg. Annual 10-Yr Treasury Yield Avg Annual Implied IG Corporate Rates
Source: Standard & Poor’s Ratings Services
7Economic Forecast
Macroeconomic
Indicators for North
American Insurance
September 2013 FORECAST
Comment/Outlook on Baseline Impact
--Upside--* --Baseline-- --Downside--* ACTUAL baseline forecast on Sector
2013 2014 2013 2014 2013 2014 2012
The poor labor market
continues to keep the Neutral
Real GDP (% change) 2.0 4.5 1.7 2.8 1.3 0.4 2.21 recovery in slow gear.
Federal Funds Rate (%) 0.1 0.8 0.1 0.2 0.1 0.1 0.1 Interest rates expected to
10-yr. Treasury note yield remain low in 2013 then
(%) 2.5 4.4 2.4 2.9 2.2 1.9 1.80 return to 2011 levels in 2014,
Unfavorable
putting downward pressure
on insurers' net investment
'BBB' bond yield (%) 5.10 6.34 4.97* 5.42* 4.61 4.95 4.94 income.
Stocks expected to appreciate
by double digit percentages in
Favorable
S&P 500 Common Stock 2013, benefiting insurer
Index 1,667 2,037 1,622 1,759 1,576 1,509 1,380 capital bases.
Modestly lower
unemployment should benefit
Somewhat
consumer income and
Favorable
confidence and lead to fewer
Unemployment rate (%) 7.4 6..1 7.5 7.0 7.6 8.0 8.07 home foreclosures.
Source: Standard & Poor’s Ratings Services
* June Data
8Rating Distribution: North America Life Insurance
2011 2012 2013
60%
52%
49%
50%
46%
42%
40% 39%
35%
30%
20%
10% 8% 8%
6% 6%
4% 4%
0% 0% 1%
0%
AAA AA A BBB Lower
Currently representing ratings of 83 interactively-rated companies and groups, as of July 2013, Dec. 2012 and Dec. 2011
Source: Standard & Poor’s Ratings Services.
9Rating Trends: North America Life Insurance
7 7 6 7 7
4 5 5 4
2 3
0 1 0
-5 -3 -4
-6 -5
-10 -10 -9
-11
-13
-17
-22
-26
-28
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Upgrades Downgrades
Rating actions within a given year; 2013 represents year-to-date totals to July 31, 2013
10Rating Outlooks: North America Life Insurance
CreditWatch Outlook Outlook Outlook Outlook
Negative Negative Stable Developing Positive
2011 6% 7% 80% 7%
1%
2012 1% 23% 72% 2%
4%
2013 8% 86% 2%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Currently representing ratings of 83 interactively-rated companies and groups, as of July 2013, Dec. 2012 and Dec 2011
11Life Insurers’ Sensitivity to Interest Rates
Life And Annuity Interest Rate Sensitivity Individual fixed annuity and universal life products are the most sensitive to both rising and falling rates. 13
Life Insurers’ Revenue And Margins
$900 24%
$800
18%
$700
12%
In billions
$600
$500 6%
$400 0%
$300
-6%
$200
-12%
$100
$0 -18%
2007 2008 2009 2010 2011 2012
Pre-Tax Operating Income Revenue Net Underwriting Margin Net Inv. Income as % of Revenue
Source: Standard & Poor’s Ratings Services
The negative impact of prolonged low interest rates on insurers
earnings and profitability could become more pronounced over
time as investment portfolios turn-over.
14Pain Points For Life Insurers If Interest Rates Spike
• Surrenders on products like FA and UL are likely to increase
when policyholders exchange contracts for competing
products with higher new money rates.
o Likely to react the fastest are sophisticated institutional clients holding
GIC, BOLI, or COLI policies) will likely respond quickly to an interest rate
spike.
o Mortality could deteriorate on some products, such as UL, because
healthier insured policyholders are better positioned to be re-underwritten
on new policies.
• Insurers could incur significant capital losses if they are
forced to sell investments at depressed values in order to
meet demands for surrenders.
• Prepayments on residential mortgages would likely slow,
causing RMBS to extend and delay insurer’s ability to deploy
principal into higher-yielding assets.
15
.Potential Benefits Of An Interest Rate Spike • Investment income could increase, particularly for long-tailed in force lines such as long-term care (LTC) and long-term disability (LTD) insurance. • The net present value of pension obligations could be reduced through higher discount rates. 16
Unrealized Gains/Losses Reflect Movements
In Interest Rates
20,000
Life Industry
10,000
0
In millions ($)
(10,000)
(20,000)
Life Industry
(30,000)
(40,000)
(50,000)
(60,000)
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: Standard & Poor’s Ratings Services
A spike in interest rates could erode current high levels of
unrealized gains and GAAP equity.
17Closing Thoughts
• Insurers are generally well positioned to cope
with most interest rate scenarios
• Our base case economic scenario assumes a
modest rise in interest rates
• Generally, a more significant rise in rates, as
contemplated by upside scenario, would be
favorable
• A spike in interest rates, which we don’t
expect, could hurt the industry from:
• Unrealized losses on investments
• Disintermediation on life and annuity products
• Potential realized investment losses
18Revised S&P Insurance Criteria
Scope of Insurance Criteria Revisions
Scope
Includes Excludes
• Life & Health • Trade Credit • Bond Insurers
Insurers Insurers
• Insurance Brokers
• Property/Casualty • Marine P&I Clubs
Insurers • Mortgage and Title Insurers
• Start-ups and
• Multiline Insurers Run-off situations
• Reinsurers • PI Ratings
20Key Messages • Framework of rating methodology is evolutionary • Fundamental view of risks and analysis is not changing • Enhances transparency and specificity of insurance criteria • Enhances comparability of insurance ratings through clear, coherent and globally consistent criteria framework • More explicitly forward-looking • More explicitly reflecting comparative analysis 21
New Criteria Framework 22
Criteria Framework – Anchor Score
Matrix
Table 1: Anchor
Financial risk profile (from table 12)
Business risk
profile (from table Extremely Very Moderately Upper Lower Less than Very Extremely
3) Strong Weak
strong strong strong adequate adequate adequate weak weak
Excellent aa+ aa aa- a+ a a- bbb+ bbb- N/A N/A
Very Strong aa aa- aa- or a+ a+ or a a a- bbb bb+ bb N/A
Strong a+ a+ or a a or a- a- a- bbb+ bbb bb+ bb- b+
Satisfactory a or a- a- a- bbb+ bbb+ bbb bbb- bb bb- b
bbb+ or
Fair bbb+ bbb+ bbb bbb bbb- bb+ bb b+ b
bbb
Vulnerable bbb- bbb- bbb- bb+ bb+ bb+ bb bb- b b
Highly
bb- bb- bb- bb- bb- bb- b+ b b b- or lower
vulnerable
23Thank You Matt Carroll, CFA Senior Director T: 212.438.3112 Matthew.Carroll@standardandpoors.com Carmi Margalit, CFA Director T: 212.438.2281 Carmi.Margalit@standardandpoors.com Permission to reprint or distribute any content from this presentation requires the prior written approval of Standard & Poor’s. Copyright © 2013 by Standard & Poor’s Financial Services LLC. All rights reserved.
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