US life insurance outlook negative as COVID-19 uncertainty looms

Ratings agencies are increasingly concerned about the significant volatility and uncertainty in the financial markets, as well as the impacts on the credit quality of life insurers, due to the ongoing coronavirus (COVID-19) outbreak, which has exposed the industry to an increased mortality risk, and declines in the equity market and interest rates.

Both AM Best and Fitch Ratings have revised the rating outlook for the US life insurance industry to negative from stable. The agencies also warned that the ratings on a number of life insurers currently with stable outlooks will be revised to negative, and those currently on negative outlook may be further downgraded.

Fitch's rating outlook revised to negative reflects significantly increased uncertainties facing life insurers associated with the material disruption in the financial markets, which may last for an extended period of time. The industry is also exposed to a spike in mortality risk, the severity of which at this point is highly uncertain.

Fitch expects the deterioration in the equity market and decline in interest rates in the near term, which will pressure life insurers' earnings, reserves and capital. While in the longer term, it expects the potential for a sustained disruption in the broader economy could cause deterioration in the credit markets, which would lead to increased bond and loan defaults and further pressure statutory capital levels.

According to the agency, financial market disruptions will affect the industry's reported financials in a number of ways, including increased reserving due to assumption revisions and for embedded guarantees associated with variable and indexed annuities, pressure on net investment yields and interest margins, increased hedging costs, and reduced fee income due to reduced asset balances.

Fitch noted that ratings in the US life insurance industry continues to benefit from strong balance sheet metrics, including very strong statutory capitalization, good asset quality and very strong liquidity position. However, even before the pressures from the coronavirus, the fundamentals of the US life insurance sector had weakened due to the sharp unexpected decline in interest rates over the past year and expectation that interest rates will remain low for an extended period of time.

In AM Best’s view, although the life and annuity (L/A) industry maintains strong capital and liquidity resources, COVID-19 will also significantly affect their ability to quickly move forward with costly innovation efforts.

AM Best's revised outlook reflects material acceleration in a global economic slowdown, increasing the expectation of dampened earnings throughout 2020 for spread and fee-driven businesses; and a rapid further deterioration in the US economy, paired with its direct impact on equities and interest rates, with a greater expectation of a longer path to sufficient improvements from record low levels for the 10-year Treasury yield, as well as a flattened yield curve.

"Carriers with less capital, questionable liquidity access and limited business profiles or outsized exposures to at-risk sectors such as energy, retail, and travel, will feel the negative economic impact faster and more deeply than most of the industry," AM Best said. "For companies active in variable products, separate account assets will be marked to market, resulting in declines in asset-based fees. L/A insurers taking on higher degrees of investment risk and those with less-than-optimal asset-liability matching strategies are likely to be more negatively impacted as well."

AM Best noted that the long-term economic impact from the outbreak of COVID-19 remains uncertain. As interest rates and the equity markets plummet, AM Best expects operating performance to move to the negative, driven by declining sales and intensifying spread compression.