Low Interest Rates Hurt Insurers' Bottom Line

Low Interest Rates Hurt Insurers' Bottom Line

By SERENA NG And LESLIE SCISM

The record-low interest rates that have been a boon for borrowers are becoming a major headache for insurance companies, which are warning of lower profitability if rates stay at current levels through next year or beyond.

Insurers Hartford Financial Services Group Inc., MetLife Inc. and Travelers Cos., among others, could see annual earnings or revenues dented by tens of millions of dollars over the next few years if the ultralow rates persist, according to estimates provided by the companies.

Insurers lately have been investing the premiums they collect in bonds that, on average, are yielding 1 to 1.5 percentage point less than bonds in their existing portfolios, leading to less investment income.

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The increasing likelihood of sustained low rates and bond yields is one reason life insurers have redesigned and re-priced some products, offering less-generous features to individuals. These include long-term care insurance and retirement-income products with minimum-income levels.

Higher prices, or lower yields on products, can impact sales. On Friday, American International Group Inc. said sales to individuals of fixed annuities, a savings product, declined this year primarily because of low interest rates.

"There is going to be more pressure on insurers to raise prices of their products to offset the low-rate environment, or they may be forced to invest in more risky assets," says Peter Andersen, a portfolio manager at Congress Asset Management Co. in Boston.

Insurers aren't the only ones who stand to lose from persistently low interest rates. With short-term rates hovering near zero, low-risk money-market mutual funds could have trouble generating enough returns to cover their own fees and expenses. Banks are earning low returns on their cash holdings. Pension funds with shortfalls between their assets and future liabilities could be in a bigger hole in a few years if bond yields stay low.

Insurance companies are sensitive to interest rates because premium dollars that constantly pour in from policyholders need to earn a decent return to help cover future claims.

Falling interest rates, however, have benefited insurers in at least one way. Because yields and bond prices move in opposite directions, bond investments in insurers' portfolios have risen in value, strengthening companies' balance sheets.

Bond yields have been on a downward march for much of the past two years amid a record rally in corporate debt and efforts by the Federal Reserve to spur growth and lending in a still-sluggish U.S. economy. The yield on 10-year Treasury notes was recently around 2.5%, compared with 3.5% a year ago and 3.7% in November 2008. On Wednesday, the Fed announced a plan to buy $600 billion of U.S. Treasurys through the second quarter of 2011, a move aimed at keeping bond yields low.

Corporate bonds, which are widely held by insurers, yield more than Treasurys but aren't paying much either. The average yield on investment-grade corporate bonds, according to an index covering different maturities, is 3.5%, down from 5% a year ago and nearly 9% in November 2008.

For property-casualty insurers that sell coverage to businesses, the low rates come amid intense industry competition, making it difficult to raise policy prices to cover investment shortfalls. Sellers of automobile, home and other property insurance typically invest the bulk of their premiums in debt maturing in one to five years, to match when claims are typically paid.

Consider this: an insurer that in 2007 bought a three-year Treasury note yielding 3.6% annually has to roll that maturing investment into a new three-year Treasury note yielding just 0.5%. Insurers' bond investments don't all mature at the same time, however, so the full impact of low rates takes time to hit, analysts say.

"To the extent rates remain low for an extended period, the choice is either to accept a lower return on capital or seek higher profitability from premiums collected," says Craig Mense, chief financial officer of property and casualty insurer CNA Financial. CNA hasn't adjusted its expectations for its long-term return targets.

Life insurers face similar woes, with a twist. Many of their policies don't pay out for decades, but bond investments backing the policies mature sooner. Insurers are faced with re-investing these funds in a lower-rate environment.

Insurers have dealt with low bond yields in previous economic cycles, and many, like MetLife, say they have financial hedges in place to take out some of the sting.

Also, many scooped up large quantities of beaten-down corporate bonds with fat yields last year, in the wake of the financial crisis; those are helping to offset some of the pain of today's lower-yielding ones.

Last month Travelers, which sells auto, home and business insurance, estimated how much its after-tax net investment income would fall over the next three years if the company reinvested proceeds from bond maturities at today's 10-year rates, other factors holding constant: $49 million in 2011, $108 million in 2012 and $162 million in 2013, all compared to 2010. In the first nine months of this year, Travelers's net investment income, after taxes, was $1.82 billion.

In reporting third-quarter earnings last week, Hartford Financial, which sells both life and non-life insurance, estimated that after-tax core earnings could be reduced by about $30 million in 2011 and $100 million in 2012 if interest rates stay at current levels. Hartford estimates core earnings of $1.3 billion for the full year 2010.

Hartford Chief Financial Officer Christopher Swift described the interest- rate environment as a "manageable headwind" for the company in a conference call Wednesday.

In a statement, MetLife said it was preliminarily estimating a reduction in 2011 operating earnings of 20 cents a share if the interest rate on the 10-year Treasury is 2.5% through 2011. Currently, analysts are estimating MetLife's operating earnings at more than $5 a share next year.

Write to Serena Ng at serena.ng@wsj.com and Leslie Scism at leslie.scism@wsj.com