8/18/16 

1 

Colin	Devine,	CFA,	CMA,	CFP®	

colin.devine@cdevineassociates.com

Aug.	18,	2016	

Federal Advisory Committee on Insurance 

Impact of Low Interest Rates on Life Insurers 

CONFIDENTIAL 

Agenda	

2 

		State	of	the	U.S.	Life	Insurance	Industry	 3

Interest	Rates	and	Investments	 8	

ImplicaJons	of	Low	Interest	Rates		 12

Other	Effects	on	Life	Insurers	 23	

Wrapping	Up	 26	
8/18/16 

2 

CONFIDENTIAL 

©UFS 

State	of	the	Industry	

CONFIDENTIAL 

Low	Rates	Universal	Challenge	

4 

Life Insurers, Individuals, Defined Benefit 

Pension Plans all in the same boat 

Impact of low rate policy means cost to fund future 

income/benefit payments far higher than planned. 

• Rising	longevity,	demise	of	defined	benefit	pension	plans,	

uncertainty	of	older	age	health	costs	and	low	interest	rates	could	

make	the	risk	of	running	out	of	assets	in	reJrement	become	a	

near	certainty	for	many.	

• While	low	rates	have	helped	housing	prices	and	equity	markets,	

the	price	of	buying	“income”	has	risen	over	20%	during	the	last	

decade	as	interest	rates	have	declined.		Benefit	of	near-term	

fiscal	policy	is	coming	at	the	cost	of	long-term	savers/reJrees.	
8/18/16 

3 

CONFIDENTIAL 

Mortality:	Good	News/Bad	News	

Longer lives means more expensive retirements. Even a 3% inflation rate requires a 

doubling of income every 23 years.

Source: Milliman, based on the Annuity 2000 Basic mortality table. 

MALE	(age	65)	

FEMALE	(age	65)	

COUPLE	(both	age	65)	

50%	chance	of	

living	beyond	

50%	chance	of	

living	beyond	

50%	chance	of	

living	beyond	

25%	chance	of	

living	beyond	

25%	chance	of	

living	beyond	

25%	chance	of	

living	beyond	

At	least	one	person	has	a...	

84	 91	

87	 93	

91	 96	

CONFIDENTIAL 

How	Are	Life	Insurers	Doing?		

6 

Capital	levels	high,	liquidity	solid,	leverage	moderate,	financial	

flexibility	good...but	profitability	stagnant.			

• Strain	from	low	interest	rates	steadily	building	and	placing	

increasing	pressure	on	reserves,	product	pricing,	policy	

dividends,	benefits	and	profits.		It	will	take	years	of	Fed	

Jghtening	to	restore	former	earnings	momentum.	

• Investment	por_olios	conJnue	to	be	of	high	quality	but	legacy	

policy	liabiliJes	may	be	where	the	bigger	risks	lie	and	the	impact	

of	low	rates	felt	the	most.	

• Unlike	banks,	life	insurers	weathered	the	financial	crisis	very	

well.		Only	two	took	TARP	and	it	was	its	non-insurance	

operaJons	that	led	to	the	Govt.	takeover	of	another	.		

Industry health in reasonable shape 
8/18/16 

4 

CONFIDENTIAL 

Industry	Statutory	CapitalizaJon		

7 

RBC not always the whole story 

Source: Estimated combined group RBC ratios based on Insurer Year-end 2015 statutory financial reports. 

500% 

549% 

632% 

648% 

310% 

317% 

369% 

394% 

397% 

430% 

449% 

486% 

487% 

487% 

490% 

491% 

505% 

619% 

930% 

0% 100% 200% 300% 400% 500% 600% 700% 800% 900% 1000% 

Mutual 

D 

Mutual 

C 

Mutal B 

Mutual 

A 

O 

N 

M 

L 

K 

J 

I 

H 

G 

F 

E 

D 

C 

B 

A 

2015 Statutory RBC Ratio 

CONFIDENTIAL 

©UFS 

Interest	Rates	and	Investments	
8/18/16 

5 

CONFIDENTIAL 

Life	Insurers	and	Low	Rates	

9 

Current	rates	well	below	levels	assumed	in	pricing	

• Between	Aug.	2007	-	Aug.	2016	the	yield	on	10-year	U.S.	Govt.	

bonds	fell	320	bps	to	1.5%.	Por_olio	yields	sJll	losing	15-25	bps	

annually	and	have	not	been	helped	by	Jght	credit	spreads.			

• Most	problemaJc	for	long	duraJon	liabiliJes	such	as	tradiJonal	

whole	and	universal	life,	long-term	care,	fixed	and	variable	

annuiJes	but	a	challenge	for	all	products.			

• Strain	on	life	insurers	would	ease	if	10-year	yield	were	to	get	

back	above	4%,	but	rates	rising	too	fast	could	cause	

disintermediaJon;	50-75	bps	annually	would	be	ideal.	

Long-term interest rates are the 

industry’s most important earnings driver 

CONFIDENTIAL 

Low	for	Long	Interest	Rates	–	New	Normal?	

End of a 30-year fixed income bull market? – What if it’s not? 

YE	11	 YE	12	 YE13	 YE14	 YE15	 08/12/16	

10	Yr.	UST	 1.89%	 1.78%	 3.04%	 2.05%	 2.27%	 1.51%	

0	

1	

2	

3	

4	

5	

6	

5/16/06	 5/16/07	 5/16/08	 5/16/09	 5/16/10	 5/16/11	 5/16/12	 5/16/13	 5/16/14	 5/16/15	 5/16/16	

	10-Year	U.S.	Treasury	Yields	

10 

Source: WSJ 
8/18/16 

6 

CONFIDENTIAL 

Investment	Quality	a	Strength	

11 

Portfolios in best shape in decades 

Investment 

Grade Corp. 

Bonds 

62.5% 

 High Yield 

5.1% 

 ABS/MBS 

13.2% 

Mortgages 

11.6% 

Policy Loans 

3.2% 

Real Estate 

0.3% Other 

4.1% 

Selected U.S. Life Insurer Average YE15 Investment 

Mix 

Source: Annual Company Reports 

CONFIDENTIAL 

©UFS 

ImplicaJons	of	Low	Interest	Rates	for	

U.S.	Life	Insurers	
8/18/16 

7 

CONFIDENTIAL 

Interest	Rates	and	LiabiliJes		

13 

• Long-duraJon	liabiliJes	require	assumpJons	for	future	

investment	rates	as	well	as	policyholder	behavior;		both	can	be	

influenced	by	a	variety	of	factors.		Unlike	banks,	insurers	make	

pricing	guarantees	they	may	have	to	live	with	for	decades.	

• Risks	of	minimum	crediJng	rate	guarantees	on	fixed	annuiJes	

and	life	insurance	policies	or	assuming	future	investment	

returns	on	premiums	are	self-evident.		

• But	variable	annuity,	universal	life	and	long-term	care	writers	

have	each	learned	a	hard	lesson	about	lapses	and	how	actuarial	

experience	can	be	adversely	impacted	by	interest	rates.	

Low long-term rates have exacerbated 

underwriting mistakes made by insurers 

CONFIDENTIAL 

All	About	UnderwriJng	

14 

Investments	may	be	sold	but	mis-priced	liabiliZes	can	last	a	

lifeZme	

• May	take	decades	for	policies	to	fully	season	and	pricing	

mistakes	to	emerge.	

• Legacy	liabiliJes	can	Je	up	capital,	depress	returns	and	take	

years	or	even	decades	to	fix.		They	also	face	growing	akenJon	

from	regulators,	raJng	agencies	and	investors.			

• AdjusJng	crediJng	rates,	de-risking	and	re-pricing	can	each	help	

improve	returns,	but	rarely	can	they	fully	put	the	“genie	back	in	

the	bokle.”			

Pricing actuaries can cost an insurer far 

more than a Chief Investment Officer 
8/18/16 

8 

CONFIDENTIAL 

Low	for	Long	

15 

Pricing	assumpZons	are	interdependent	and	adverse	experience	

on	one	assumpZon	can	impact	actuarial	experience	for	others		

• Individual	life	insurance,	annuiJes,	pension	close-outs	and	

supplemental	health	products	such	as	long-term	care	and	

disability	income	can	be	on	an	insurer’s	books	for	20	years	or	

more.		Back	in	Aug.	2006,		the	10-year	yield	was	5.0%.	

• With	the	steady	decline	in	long-term	rates	and	resulJng	lower	

levels	of	guarantees	on	new	products,	the	intrinsic	value	of	inforce	policies	has	risen.		They	are	not	lapsing	and	will	require	

insurers	build	higher	levels	of	reserves	to	pay	future	claims.	

Interest rates not only impact spreads but 

also policyholder behavior and benefits 

CONFIDENTIAL 

ImplicaJons	of	Adverse	Lapse	Experience	

Interest rates can impact policyholder behavior

Year	5	 Year	10	 Year	15	 Year	20	

5.0%	lapse	rate	 77.4%	 59.9%	 46.3%	 35.8%	

7.5%	lapse	rate	 67.7%	 45.9%	 31.1%	 21.0%	

10.0%	lapse	rate	 59.0%	 34.9%	 20.6%	 12.2%	 16 

0.0	

20.0	

40.0	

60.0	

80.0	

100.0	

120.0	

0	 1	 2	 3	 4	 5	 6	 7	 8	 9	 10	 11	 12	 13	 14	 15	 16	 17	 18	 19	 20	

IniZal	Policy	Count	

Years	since	underwriZng	

5.0%	lapse	rate	

7.5%	lapse	rate	

10.0%	lapse	rate	

Changes in lapses can cause material changes to future 

benefit payments, reserves, and capital requirements 
8/18/16 

9 

CONFIDENTIAL 

Low	Interest	Rates	and	Japan		

17 

Regulatory	intervenZon	played	an	important	role.	

• CombinaJon	of	very	low	long-term	interest	rates,	limited	

corporate	bond	market,	high	minimum	crediJng	rate	guarantees	

and	poor	quality	investments	led	to	several	insolvencies.	

• However,	many	companies	also	benefited	from	extremely	

favorable	mortality	gains	due	to	the	industry’s	use	of	highly	

conservaJve	historic	mortality	tables.	

• While	interest	spreads	for	most	Japanese	life	insurers	are	sJll	

negaJve,	it	is	slowly	improving	and	conJnues	to	be	offset	by	

mortality	experience	that	remains	very	posiJve.	

Japanese life insurers have managed 

through decades of low interest rates 

CONFIDENTIAL 

Legacy	liability	examples		

18 

• Individual	disability	–	Non-cancellable	own	occupaJon	policies	

that	one	insurer	wrote	up	unJl	the	early	90’s	sJll	represent	

about	one-third	of	its	general	account	reserves.		No	ability	to	

raise	premiums	to	offset	drop	in	interest	rates.		Approx.	95%	are	

on	claim	and	block	lapsing	at	around	5%.	

• Variable	annuiZes	-	Insurers	quick	to	provide	generous	living	

benefits	but	slow	to	recognize	increased	risks	as	they	became	

SPIAs	in	“disguise.”		Benefit	uJlizaJon	tracking	over	80%	with	

lapses	of	5%-8%	vs.	10%-plus	assumed	in	pricing.		Equity	market	

recovery	has	helped	reduce	“in	the	moneyness”	of	guarantees.	

Low interest rates have exacerbated 

underwriting mistakes made by insurers 
8/18/16 

10 

CONFIDENTIAL 

What	changed	for	Variable	AnnuiJes

IRAs became dominant source of funds for living benefits

19 

41% 

51% 

53% 

58% 59% 60% 

49% 

47% 

42% 

40% 

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 11 '12 13 

Percent of Deferred VA Retail Sales 

IRA Nonqualified 

Source: U.S. Individual Annuities survey, LIMRA SRI . Retail = IRA + Nonqualified annuity sales. 

CONFIDENTIAL 

LiabiliJes	cont’d.		

20 

• Universal	life	–	Insurers	have	been	implemenJng	significant	

increases	for	cost	of	insurance	(COI)	to	offset	far	lower	

investment	returns	than	assumed	in	pricing.		Causing	much	faster	

cash	value	erosion	and	has	spurred	a	host	of	lawsuits.		Policies	

with	secondary	guarantees	have	lifeJme	pricing	effecJvely	

“locked	in”	with	limited	ability	to	change	COI	and	are	also	facing	

higher	capital	requirements.		

• Long-term	care	–	Pricing	overly	reliant	on	lapse	support.	To	

compensate	for	uninsurable	older	age	health	risk	and	lower	than	

assumed	investment	returns	on	renewal	premiums,	carriers	have	

exited	the	market	while	others	are	seeking	rate	increases	of	20%,	

30%,	40%	or	more.	

“Measure twice cut once” 
8/18/16 

11 

CONFIDENTIAL 

Low	Rates	Mean	Higher	Future	Reserves

Liability reserves build up over many years. For Products 

such as SGUL, LTC, and VA Insurers may face much higher 

reserve levels to generate sufficient returns to pay claims 

payments

21 

Source: Ernst & Young. 

In response too low rates the 

GAAP reserve may grow to the 

size of the SAAP reserve or more. 

CONFIDENTIAL 

AdapJng	to	Low	for	Long	Rates		

22 

Carriers	have	raised	premium	rates,	reduced	benefits	and	exited	

product	lines	such	as	VAs	and	LTC	due	to	adverse	experience.		

• AnJcipate	growing	shir	to	combinaJon	or	linked-benefit	

products	that	provide	more	flexibility	for	future	re-pricing	as	

well	as	upside	“parJcipaJng”	potenJal	for	policyholder	if	

experience	is	favorable.	

• Look	for	greater	focus	on	high	persistency	products	priced	for	

“zero”	rate	environment	that	can	transiJon	through	life	stages	

without	lapse	supported	pricing.	

• Increased	use	of	riders	so	policyholders	can	customize	products	

to	their	needs	and	allow	insurers	to	more	effecJvely	price	risk.	

Life industry adapting and re-inventing 
8/18/16 

12 

CONFIDENTIAL 

©UFS 

Other	effects	on	Life	Insurers	of	Low	

Interest	Rates	

CONFIDENTIAL 

Share	ValuaJons	Have	Lagged		

24 

Financials	are	sZll	only	sector	of	S&P	500	that	have	not	returned	to	precrisis	share	valuaZon	levels.	

• Between	2006-16	life	shares	off	approx.	3%	vs.44%	gain	for	S&P	500.		

YTD	S&P	Life	index	down	1.3%	vs.	6.9%	gain	for	S&P	500.		

• Life	insurer	valuaJons	may	be	looking	through	accounJng	and	in	line	

with	historic	levels	on	discounted	fair	value	“economic”	basis.	

Anticipate life stocks will largely trade in 

line with direction of interest rates 

Price / Book Ratio 2006 2008 2015 08/12/16 

S&P 500 2.9x 2.0x 2.8x 2.9x 

Life/Health Insurers 1.7x 1.4x 0.9x 1.1x 

P/E Ratio

S&P 500 17x 16x 18x 16x 

Life/Health Insurers 14x 10x 11x 10x 
8/18/16 

13 

CONFIDENTIAL 

M&A	Warming	up	-	Somewhat		

25 

Notable	recent	deals	include:	

ProtecJve	Life	–	Dia-ichi	$5.7B	

StanCorp	–	Meiji	Yasuda	$5.0B	

Symetra	–	Sumitomo	$3.8B	

• Look	for	M&A	to	stay	moderate	with	a	focus	on	opportunisJc	

disposiJons.		Will	conJnue	to	be	a	reluctance	to	take	on	

problems	of	others	–	many	have	enough	of	their	own			

• Regulatory	issues	may	cause	some	insurers	to	re-think	their	

presence	in	the	U.S.		Could	take	the	form	of	out-right	spin-offs,	

divesJtures	or	business	line	sales.	

Resurgence led by Japanese buyers 

CONFIDENTIAL 

©UFS 

Wrapping	Up	
8/18/16 

14 

CONFIDENTIAL 

	CauJously	OpJmisJc	Outlook	

27 

Low	interest	rates	pose	a	formidable	risk	but	confident	industry	is	

already	adjusZng	business	models	to	a	new	paradigm.	

• Life	insurance	sector	possesses	good	long-term	growth	potenJal	

Jed	to	favorable	demographic	trends	and	a	shir	in	focus	towards	

protecJon	against	rising	longevity	vs.	premature	mortality.			

• Industry’s	ability	to	conJnue	providing	products	to	help	reJrees	

manage	financial	security	is	at	risk	and	will	be	Jed	to	direcJon	of	

interest	rates,	regulatory	capital	reforms	and	consumer	protecJon.			

• Restoring	earnings	momentum	will	be	slow	but	do	not	anJcipate	a	

future	“solvency”	crisis	for	life	insurers.		EffecJveness	of	exisJng	

regulatory	supervision	was	veked	during	the	financial	crisis.	

Life Insurance is a marathon not a sprint 

CONFIDENTIAL 

	Why	Life	Insurers	Maker	

28 

Three	closing	thoughts:	

“Americans	should	convert	at	least	half	of	their	re4rement	

savings	into	an	annuity”	US	Treasury	Dept.	

“There	is	a	lack	of	financial	educa4on	about	the	benefits	of	

annui4es	and	what’s	available”	US	Government	Accountability	

Office	

Ben	Bernanke,	former	U.S.	Federal	Reserve	Chairman,	owns	

two	annui4es	which	represent	the	largest	percentage	of	his	

own	personal	investment	holdings.........so	do	I.	

Only life insurers can guarantee lifetime 

income and offer tax-free death benefits 
8/18/16 

15 

CONFIDENTIAL 

Thank You

29 

CONFIDENTIAL 

Colin	Devine	provides	strategic	advisory	services	to	the	insurance	and	investment	

management	sectors	on	a	host	of	industry	issues	including	capital	and	risk	

management,	general	account	investments,	variable	annuity	de-risking,	

reJrement	income	products	and	investor	relaJons.		He	is	also	a	frequent	guest	

speaker	at	various	industry	conferences	as	well	as	corporate	boards	of	directors.		

Previously,	Colin	was	a	Managing	Director	with	both	Jefferies	LLC	and	CiJgroup	

responsible	for	equity	research	coverage	of	North	American	life	insurance	

companies.		He	was	on	the	InsJtuJonal	Investor	All-America	Research	Team	for	

14	straight	years	where	he	held	the	#1	ranking	in	the	Life	Insurance	Equity	

Research	category	for	six	consecuJve	years.		Colin	was	also	named	one	of	the	

“Last	Honest	Analysts”	by	Smart	Money	Magazine.	

Before	joining	CiJgroup,	Colin	was	a	Director	in	Standard	&	Poor's	Insurance	

RaJngs	group.		Preceding	that,	Colin	was	a	vice	president	of	a	major	Canadian	

life	insurer	where	he	was	involved	in	investment	and	risk	management	as	well	as	

a	number	of	corporate	development	and	treasury	iniJaJves.		 30 

	Colin	W.	Devine	CFA,	CMA,	CFP®