Rising Interest Rates Sure to Bring Shifts to In-Force Life and Annuity Products
With the Federal Reserve in an aggressive rate-raising mode for the first time in a decade, its moves could create a fault line between newly issued life and annuity products. After years of shifting to products that are less interest-sensitive, the industry may also see a move back the other way.
- Terrence Dopp
- November 2022
- Development: Spurred by rising inflation, the Fed has been raising rates throughout 2022 and may continue doing so into next year.
- In-Force: While the development may at once be music to the ears of the industry, it also comes after years of shifting toward registered index-linked annuities and other life products that bring less exposure to interest rates.
- Future: While it’s too early to tell exactly what impact that shift will have, change is the one constant of economics.
Rising interest rates are bringing mixed news for life and annuity insurers.
After a decade of historic lows, interest rates are rising and the pattern could hold for a bit, allowing them to hold their own on balance sheets.
It could also likely mean some portion of the more than $3 trillion in policies they wrote in 2021 could be impacted.
The question is how that plays out and what impact it has on those in-force products issued during a decade of low rates.
“It's positive for the industry on their own balance sheets but it will also make certain fixed annuities and life products like universal life more attractive,” said Thomas Holzheu, Swiss Re's chief economist for the Americas. “These higher rates allow insurers to also re-price and offer new products on more attractive terms. That's particularly relevant for savings and accumulations types of products.”
Holzheu said rising rates are significant for the entire insurance industry and could result in shifting product mixes, which he said the industry has proven to be adept at altering when reacting to interest rates. He said changes have been primarily clustered on the life and annuity side in recent years.
“They are long-term investors and so overall it's a positive development,” he said.
In September, the Federal Open Market Committee of the Federal Reserve raised its benchmark interest rate by three-quarters of a percentage point to a 14-year high.
Crucially, Fed Chairman Jerome Powell said the hikes would continue for the remainder of the year and stretch into 2023.
Andrew Melnyk, vice president of research and chief economist at the American Council of Life Insurers, said that for many life insurers a smooth rate trajectory would be preferable. He called the rates set recently by the FOMC a “blip in time” given the industry's longer-term focus.
“A more gradual increase in interest rates would allow companies to adjust assets in a more efficient and effective manner,” he said. “Even so, life insurers' assets are designed to deliver guaranteed benefits that could come due 20 or 30 years down the road.”
In many real respects, the current interest rate environment—dubbed “higher for longer”—is the exact opposite of the preceding decade, in which the term-of-art was “lower for longer” as rates stayed artificially low in the wake of the 2008 financial crisis.
The increases are meant to throttle inflation and cool the economy.
The trick will lie in cutting the balance with enough of a shock to tame inflation but not so much that the fallout plunges it into a deep retraction. As of now, the Fed is predicting a rise in unemployment to 4.4% in the coming year along with gross domestic product growth of 1.2%.
Life and annuity carriers stepped up other areas of investment as they searched for yield, with movement toward private placement lending, collateralized loan obligations and other classes that often trade liquidity for higher returns.
Holzheu indicated that the increased interest rates are positive, although he said softening of the labor market and a likely recession could mean the life insurance industry sees a sales slowdown in 2023. “You have to live through 2022 and 2023 with a lot of volatility on asset returns,” he said.
Along the way there could be some choppiness for insurers, he said. The simplest term policies will largely not see any impact; however, with accumulation-centered policies, that could change with an impact on both future policies and those currently on the books.
Michael Porcelli, a senior director with AM Best, said the trajectory of the rate increases is what will determine how great the impact is on existing books of business in the short run.
“Rising rates in the long run are good but rates that rise too quickly can be disruptive and troublesome for the industry,” he said. “The reason for that is that there are interest-sensitive liabilities with policyholder optionality that could force asset sales at a time when rates have risen.”
For example: Someone with a universal life policy or anything with an accumulation component could decide to turn it in and take their premium money somewhere with higher interest crediting. While predicting how future product mixes shift is speculative at this point, both Porcelli and Holzheu cited this as a possible outcome.
“Rising rates in the long run are good but rates that rise too quickly can be disruptive and troublesome for the industry.”
Life insurers industrywide issued more than $3 trillion worth of business in 2021, a decrease of 0.9% from the prior year, showing stability even as the U.S. economy began to shake off the roller-coaster ride of COVID-related shutdowns, according to a Best's Ranking of the industry.
As rates started rising in 2022, the virus-caused growth in life business began to slow down. The same pressures that have prompted the Fed's fight—a consumer price index that's risen at 40-year highs—have also impacted another side of the industry as consumers felt the financial pinch of higher costs and, in some cases, let policies lapse that seemed crucial during the height of the pandemic.
According to industry tracker LIMRA, total U.S. life insurance new annualized premium increased 11% in the first half of 2022 compared to one year earlier, with variable life driving the increase. Yet, underneath the headline figure, overall policy sales fell 9% year-to-date as financial pressures cut into family budgets.
The shift was already taking place as the first half of the year came to a close.
New annualized premium in the indexed universal life segment—which accounted for about 28% of the life insurance market—increased by 33% in the first half of the year driven by cash-value accumulation products. Variable universal life is 13% of the life insurance market and increased by 38% in the six-month period.
Results for whole life products were a bit softer.
New annualized whole life premium—which saw a 25% increase in the second quarter of 2021 as the pandemic raised awareness—increased by only 3% in the first half of the year despite registering a 3% drop as the rate increases began. Whole life accounts for about a third of the life insurance market. Sales of term life products, which make up 19% of the market, fell 4% in early 2022.
Porcelli said if the current environment unfolds in traditional ways, it's possible for life insurers to see new market entrants into the most interest-sensitive lines after years of carriers trying their best to become less sensitive to rate fluctuations.
“It creates opportunities for companies that were on the sidelines,” he said. “They can start with a newer and cleaner portfolio that is already going to be yielding higher. But for that to happen there's got to be a view that we're at the top of the interest rate cycle and we don't know when that's going to happen.”
“You can earn a return on simple fixed-income investment with fixed-rate annuities. They have been unusually unattractive for over a decade and now things are coming back.”
On the annuities side are two widely divergent categories: fixed-rate annuities—in which a customer contracts to hand over money with a set return—and variable-rate products that can slide depending on set factors or conditions.
Perhaps the most interest-sensitive product of all are fixed annuities. Porcelli said rising rates can entice new market entrants and the attractive rates they're able to offer consumers can have a big impact industrywide after years marked by a shift to lower guarantees.
“Some of the new entrants can have very clean balance sheets and are able to offer higher crediting rates,” he said. “The legacy players were competing for business in a lower-rate environment. So you've got that on the fixed side.”
On the variable annuity side, companies may find that as the rates rise and stocks fall some equities-linked variable annuities are “in the money” and as a result carriers need to cover losses, he said. The same products that were increasingly common in the days of lower rates, such as registered index-linked annuities and others with a loss-buffer, could be less attractive to insurers.
“They're not going to transact unless they want to take a loss,” Porcelli said. “A lot of them are thinking they don't want to transact right now.”
Holzheu of Swiss Re said the fixed products have the most to gain as rates go up, attracting a mix of both rollovers at the higher levels and enticing new money. A reversal may be in store for the movement away from fixed products, he said.
“That will be a reflection of a shift in asset allocation in general. We had a decade or more of suppressed rates and any fixed-income investment was less attractive,” Holzheu said. “You can earn a return on simple fixed-income investment with fixed-rate annuities. They have been unusually unattractive for over a decade and now things are coming back.”
Variable annuities, if linked to equities, at the current moment appear “dire” from the consumers' view, he said. “Fixed income and fixed returns look like a safe haven,” Holzheu said.
“There's a risk-averse sentiment regarding the equity-type investment. On the other hand, safe havens are starting to earn real returns and that drives some of this shift back.”
Looking ahead, Roger Crandall, chairman, president and chief executive officer of Massachusetts Mutual Life Insurance Co., said his company over the past year brought out a host of newer life and annuity products that are at the core extensions of existing ones. While the company currently deals primarily with whole life and term products, he said the mix of those products could shift if needed to address changes brought on by rising rates.
Massachusetts Mutual Life Group is the fourth-largest U.S. life/health insurer based on 2021 admitted assets, according to AM Best.
“Particularly, you'll have to be updating pricing very rapidly on annuities given the level of rate moves we're seeing—it's not unusual now to have moves in a day that you might not have seen in a month all that long ago. You need to make sure you're quick on your pricing there,” he said. “If the yield curve inverts and stays inverted for a while, we certainly do manufacture universal life products and that may be a bigger part of the market.”
The current picture is quite different from previous models: Rates have bounced up and down in the past, but now they are rising after a decade of being held at unusually low levels, industry leaders and analysts say.
As a result, the true shift could be put off to the future as all sides of the transaction wait to see just how high they will rise.
On top of that, the low starting point means that even with the increases interest rates just aren't anywhere near approaching historical highs, Porcelli said. He said the industry looks completely different than it did in the late 1970s or early '80s when the Fed was in sustained increase mode.
“The industry definitely does react to interest rates in its product offerings,” he said. “The historical record is not going to be as interesting as what happens now because the product offerings in the past weren't anywhere near as complex as they are now.”