Fitch: Sector Outlook on U. S. Life Insurers Revised to Negative
At the same time, the Rating Outlook on the U. S. life insurance sector remains Stable. Rating Outlooks indicate the direction in which ratings are likely to move over a one to two year period.
Key macroeconomic challenges impacting U. S. life insurers include declining interest rates and increased financial market volatility, which are expected to have a more pronounced impact on the industry's earnings profile and reserve adequacy relative to Fitch's base case scenario for 2016 and 2017. While we don't anticipate immediate implications for ratings of most companies, deterioration in the macroeconomic environment in 2016 exacerbates an already challenging operating environment for U. S. life insurers.
Over the past several years, U. S. life insurers have been able to largely mitigate compression of interest margins on spread based products through active management of crediting rates, interest rate hedging, and new business repricing. However, the industry's ability to further reduce crediting rates on in-force business has become increasingly limited. As a result, the decline in portfolio yields supporting legacy in-force business over the past one to two years has led to more meaningful deterioration in interest margins and an increase in reserve charges, which have led to declines in operating earnings, a trend we expect to continue over the near term.
The Stable Rating Outlook reflects Fitch's view that the impact of low interest rates remains manageable in the context of the industry's earnings and capital over the near term, and key credit metrics should largely remain consistent with current ratings.
Existing ratings continue to reflect the industry's strong balance sheet fundamentals, very strong liquidity, disciplined asset-liability matching, and operating performance that remain generally in line with rating expectations. To date, expected deterioration in corporate credit exposure from the energy sector has been manageable and credit impairments remain below long-term averages and product pricing assumptions.
However, should interest rates remain at current low levels or decline further, Fitch would likely revise its Rating Outlook to Negative on both the sector and a cross section of individual companies. Without an uptrend in interest rates, Fitch believes this could occur within two to three years on an expectation of deterioration in key profitability metrics and reserve adequacy. As one point of context, Fitch would view a further decline in the industry's GAAP operating return on equity (ROE) by 1.5 to 2.0 percentage points as a potential ratings trigger. Over the past year, the industry's average ROE has been in the 11%-12% range. The timing of any Rating Outlook revisions will be influenced by conditions in the credit and equity markets, which are key historical drivers of rating changes on life insurers.
Low interest rates is a negative scenario across all major product lines, but is particularly adverse for interest-sensitive products such as fixed annuities, universal life and long-term care. However, Fitch anticipates that the rating impact associated with low interest rates will not be uniform across the industry. U. S. life insurers with highly diverse sources of revenue and earnings are generally less vulnerable to low interest rates. Furthermore, companies with seemingly comparable liability profiles could be impacted by interest rate changes in materially different ways based on their specific asset-liability management strategies and exposure to legacy in-force business with relatively high minimum rate guarantees.
Fitch will provide further detail on our views of the industry in our annual outlook report to be published in December 2016.