Friday, February 20, 2009
Life Insurance 2009 Outlook
-->Unlike banks funding on deposits and brokers on short term liability, 80% funding came from policy liabilities. While policies can be redeemed, the embedded features such as surrender fees make it more stable source of funding relative to deposits or repos. --Risk Based Capital (RBC) is a measurement of the amout of captial the company holds to support the degree of risk associated with its operation. ratio: capital/ risk based captial %, 350% is consistent with AA rating. --An important distinction between life and P&C sectors relate to statutory accounting rules. For life and health statutory accounting, unrealized gains. For life and health insurance statutory accounting, unrealized loss will not flow through statutory capital. Realized loss in credit assets and unrealzied equity loss is recored ed in an item asset valuation reserve (AVR). GAAP accounting rules that unrealized loss flow through comprehensive income, consistent across life and P&C insurers. For P&C insurers, the unrealized loss in equities are not reflected in statutory capital or net income. As a result, life insurers experienced more deterioration. --Insurers have two basic means to increase spreads. They can either use the term structure of rates, investing in longer maturities which shortens the duration of their liabilities (go long duration), or they can chase yield by opting for higher risk investments. Beause of the flatness of yield curve in the past few years, they have little incentive to extend asset duration. Consequently, a number of insurers have been loading on to RMBS and ABS back by residential mortgages to juice returns. The bulk of insurers' assets are invested in fixed income (corporate debt 50% and ABS 20%) --CMBS has been a large percentage of insurers' equity --Insurers are opposed to mark-to-marketing accounting though accounting has value from investors transparency perspective. Current regulatory discussions lead us to believe that some form of compromises is the most likely outcome. --M&A will be wild card. The market is fragmented and competitive, some firms might want to grow inorganically. But with capital deteriorated, few firms have the financial capacity to make an acquisition. Over 1000 companies offer life and annuity products. --Metlife and prudential are most likely consolidators. Metlife has excess cash and capital level above $20 bil. --interest rate risk will be a major threat. In the current low rate environment, minimum garantee on fixed annuity products will be in high demand. An sharp increase in interest rate will cause an increase in surrenders which can strain liquidity. While minimum garantee products helped to stem disintemediation risk from banks and other non-life players, the optionality has resulted in gradual balance sheet deterioration.