Rising interest rates suppress debt appetite for US L/A insurers

Written by Adam Cadle

09/01/2023

Publicly traded US life/annuity insurers are taking a more-cautious approach to issuing debt given rising interest rates, and instead have put a greater focus on strengthening their enterprise risk management, corporate governance and stress testing capabilities, according to AM Best.

In its latest report, AM Best said the prolonged low interest rate environment and cheap capital has allowed L/A insurers to strengthen their balance sheets by replacing higher-cost debt with significantly lower-cost alternatives over the last five to 10 years. However, this scenario may be coming to an end as the 18 publicly traded US L/A companies followed for the report kept their appetite for long-term debt in check in 2022.

“Many insurers have already taken advantage of lower financing costs to pay down their near-term debt maturities and are now taking a wait-and-see approach with respect to interest rates, particularly with yield curve inversions occurring,” said Jason Hopper, associate director, industry research and analytics at AM Best.

Total debt and notes payable increased slightly from year-end 2021 through the third quarter of 2022, with long-term debt rising marginally by 1% owing to a handful of more-frequent issuing companies. However, there have been notable declines in capital at many companies on a GAAP basis due to the accounting impact of rising interest rates, which has led to large unrealised losses on fixed income portfolios from the reduction in bond values. This in turn has led to higher financial leverage, or long-term debt to adjusted shareholders’ equity, ratios, with the industry aggregate climbing by more than 20 percentage points, to 42.5%, in the third quarter of 2022 from year-end 2021. Furthermore, the number of companies with ratio over 33% in 2022 tripled from year-end 2021 to more than half.

Despite the increase in leverage, interest coverage remains healthy for L/A insurers. More than 40% of companies at year-end 2021 had an interest coverage ratio that is greater than 10 times earnings before interest and taxes. Earnings have varied for three quarters throughout the year, and macro-economic challenges, including inflation and capital market volatility, are expected to reduce profitability compared with prior years. In addition, the decreased value of bond holdings has resulted in unrealised losses on fixed maturities. However, the life industry follows a hold-to-maturity investment strategy, and therefore, the unrealised losses and hit to capital only become permanent if those assets are sold at the current discounted market value price, realising those losses.

“Uncertainty about the direction and pace of interest rate changes further demonstrates the need for a strong asset-liability matching program and routine rigorous stress testing of insurers’ investment portfolios and liquidity positions,” Hopper said.

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