Life Insurers' Profits Rise, but They're Hardly Recession-Proof

Despite a 9% increase in the profits of life insurers in the first nine months of 2007 (the most recent full set of available data), the industry now faces challenges from recessionary pressures.

Through Sept. 30, 2007, life insurers -- including annuities, life insurance, disability insurance, long-term care insurance, and health insurance -- earned $30.2 billion, up from $27.7 billion for the same period in 2006.

TheStreet.com Ratings recently released its updated financial-strength ratings based on third-quarter 2007 data. Fourteen ratings were downgraded and 103 were upgraded.

TheStreet.com Ratings' conservative approach includes evaluating insurers' ability to withstand an economic adversity and a sharp increase in claims. This is because an insurer must be able to honor its policy commitments in bad times as well as good.

Melissa Gannon, vice president of insurance and bank ratings for TheStreet.com Ratings, discusses:

Q: First, let's talk about the good news. The industry's profits are increasing. To what do you attribute that?

A: The largest companies in the industry really lead the charge here. Prudential Insurance Company of America, owned by Prudential Financial PRU, Metropolitan Life Insurance Company, owned by MetlifeMET, and Lincoln National Life Insurance Company, owned by Lincoln Nation LNC combined to increase their earnings by $2.2 billion.

In aggregate, premium volume increased $26.3 billion, or 6%, for the first nine months of the year primarily because of sales of retirement products focusing on asset accumulation. In addition, the industry's investment income grew $5.9 billion, or 4.9%, to $127 billion from $121 billion for the first nine months of 2006.

Q: Are you concerned about the impact of a recession on the industry?

A: The industry as a whole is very strong. But the companies that are already operating at a higher risk profile are the most likely to suffer. Companies with a financial strength rating of B+ or higher are those most likely to weather a recession with little damage.

A recession can affect the industry in a variety of ways including declining product sales, increased risk of default by bond issuers, falling equity markets, increased disability claims, and higher surrenders on life insurance policies.

The length and depth of a recession, of course, will determine how severely the industry is affected, but we are already seeing a decline in capital gains earned on the sale of investments.

Monumental Life Insurance Company, owned by AegonAEG, suffered a capital loss on the sale of investments of $637 million through the third quarter of 2007, Beneficial Life Insurance Company lost $206 million, and AIG Annuity, owned by American International Group AIG lost $113 million.

Q: How do falling interest rates affect life insurers?

A: Falling interest rates affect insurers that have a concentration in products that require a fixed payout, such as fixed annuities, whole life, universal life, and disability insurance. As interest rates decline, the margins on these product lines are squeezed. For consumers, this means that rates paid on fixed annuities and whole and universal life polices will be lower at the time of purchase.

Q: Insurers hold a lot of bonds. Have they been affected by the subprime mortgage crisis?

A: Estimates indicate that life and annuity companies won't be affected much by this crisis. At year-end 2006 (the most recent data available) the industry held $263 billion in mortgage-backed securities. When 2007 data are available, we expect to see some bond downgrades and a few defaults but nothing that the industry can't absorb given its healthy capital level.

Q: What do you look for when rating a company?

A: We evaluate companies on several levels including capitalization, investment quality, profitability, liquidity, and operational stability. Companies are put through stress tests to determine their ability to withstand moderate and severe economic downturn. This conservative approach allows us to identify companies early that are not positioned to weather the storm before it hits.

The current financial strength ratings for all life, health, and annuity insurers as well as property/casualty insurers can be found at the Ratings Screener.