With U.S. interest rates at their lowest since right after World War II, chief financial officers (CFOs) at North American life insurance companies — particularly those with significant exposure to fixed-rate products — are under substantial financial pressures. According to data from a recent survey from global professional services company Towers Watson, Life Insurance CFO Survey: Low Interest Rate Environment, life insurance CFOs said the current low interest rate environment is their primary business concern, as almost half (45%) of the survey respondents emphasized that a prolonged low interest rate environment is the greatest threat to their business.
Further, life insurance CFOs are not optimistic about the immediate economic future. Eighty-seven percent of all respondents believe there is a 50% or greater likelihood of a major disruption to the economy in the next 12 to 18 months, with 27% saying there is a 75% likelihood and 7% saying the
likelihood of a major disruption is almost certain.
Against this backdrop, CFOs do not expect the low interest rate environment to change quickly. Over two-thirds (68%) said they expect a three- to five-year period of low interest rates, followed by a gradual increase. When asked to consider their organization's interest rate risk exposure, CFOs' metrics of greatest concern were their levels of statutory capital (63%), followed by their level of statutory earnings (53%).
"Life insurers are adversely affected by low interest rates, in part, because of lower returns on their investments and previous guarantees promised to their policyholders," said John Fenton, senior life insurance consultant at Towers Watson. "In addition, the low interest rate environment makes some of their products very unattractive in the marketplace, such as traditional fixed universal life and annuities," said Fenton.
In response to the low interest rate environment, CFOs said they are considering or taking a number of actions to control interest rate risk. More than half (57%) said their company has established risk tolerance limits for interest rate risk; however, 43% have not done so, and over 40% of CFOs with established rate risk tolerance limits indicated they have breached them. "This raises serious questions about how these companies are dealing with interest rate risk management. Most companies have a critical need to revisit their interest rate risk strategy in light of the current economic environment," said Karen Wells, senior investment consultant, Towers Watson.
CFOs have increased the cost of insurance rates for interest-sensitive products as a way to better manage their interest rate risk. Forty-three percent of respondents said, based on future expectations, the language of their policy forms allows them to change cost of insurance (COI) rates under the universal life products they sell based on investment earnings, while 50% said they can change COI rates for variations in mortality alone. Many are taking advantage of this provision in their policies. In the past five years, just over a third of respondents have increased COI rates, expense loads or both on at least some part of their life block.
Survey respondents have also implemented product change strategies, or are considering implementing them, as a result of the low interest rate environment. Nearly all respondents have taken significant steps, and virtually all (96%) have reduced their minimum guarantee on fixed-account products. Over half (56%) have adjusted their premium rates, reduced living benefit guarantees or adjusted fees on annuity products (56%), or ceased or significantly curtailed sales of some products (54%). One-quarter have even taken the step of exiting product segments, and another 13% plan to do so in the next six months.
"Interest rates are a fundamental risk for life companies if they remain at current levels or move dramatically. Insurers need a forward-looking plan for managing the enterprise if interest rates stay low for an extended period of time. They also need a risk management plan for a sharply rising interest rate scenario. Based on the survey, many life insurance companies do not appear to be well prepared for either scenario," said Fenton.
CFOs predict growth, despite current environment
Despite their unfavorable near-term outlook on the economy, CFOs are more optimistic about improvements in their financial results. Seventy-one percent of respondents expect increases in new life and annuity premiums of 4% or more in the first quarter of 2012, compared to the same period in 2011. Over 80% expect GAAP net revenue to grow by 4% or more in the first quarter, compared to the same period in 2011. When compared to expectations from Towers Watson's last CFO survey, this represents a notable increase in optimism: When asked about expectations for the third quarter of 2011, only 43% predicted increases in new life and annuity premiums of 4% or more, and just 50% anticipated a GAAP net revenue increase of 4% or more. Adding to the sense of optimism, 50% of respondents predicted GAAP net income will increase by 4% or more compared to the first quarter of last year.
About the Survey
Thirty CFOs, 19% of the 162 North American life CFOs invited, participated in Life Insurance CFO Survey: Low Interest Rate Environment. Because each survey question was not applicable to each participating company, the respondent base varies from question to question. The respondents are primarily from large and midsize life insurance companies in North America; 67% of respondent companies have assets of $5 billion or more, and 20% are multinationals.