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Falling interest rates to drag on life insurers' investment results

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Falling interest rates to drag on life insurers' investment results

Declining interest rates are expected to take a toll on life insurers' investment portfolios as maturing bonds are reinvested into bonds with weaker yields.

Life insurance companies are generally heavily invested in fixed-income securities. As of year-end 2018, life insurers' aggregate unaffiliated bonds made up roughly 75% of their total investable assets.

The yield on the 10-year Treasury has slumped this year, falling from 2.69% on Jan. 1 to 1.73% as of Sept. 10, as the outlook on the global economy soured. Worries over global growth were one major factor behind the Federal Reserve's July 31 decision to lower interest rates by 25 basis points. The market expects another rate cut at the Fed's September meeting.

This persistent low-rate environment puts "downward pressure" on overall net investment income, yields and earnings, but could also be particularly impactful when it comes to reinvesting, said Moody's analyst Bob Garofalo.

"Lower investment returns on new money will drive down the overall company investment yields," Garofalo said. "Thus you'll have lower net investment income, which could lead to lower earnings."

MetLife Inc., Prudential Financial Inc. and Massachusetts Mutual Life Insurance Co. will each see more than 10% of their bond holdings mature before the end of 2019, which means they will likely have to reinvest at a time when interest rates were much lower than where they were just a year earlier. Athene Holding Ltd. and Principal Financial Group Inc. are in a similar situation as just under 10% of their bond portfolios mature this year.

Given the current environment, life insurers are falling short of their original expectations for how much new investments will yield, according to B. Riley FBR analyst Randy Binner.

"If you look at where they're putting money toward today versus where their ultimate assumptions are, I'd say most insurance companies are at least 100 basis points off," Binner said. "It's not just a near-term earnings issue, but it becomes a bit of a balance sheet question longer term."

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Despite the low rates, life insurers continued to push money into fixed-income securities in the second quarter, purchasing almost $184 billion in unaffiliated bonds, while selling $161.2 billion. On a net basis, actual costs at acquisition minus considerations at disposal, the life sector's holdings of bonds grew by $23.2 billion, the most of any investment asset class. Almost two thirds of the net increase went into BBB-rated bonds, classified as category 2 under the National Association of Insurance Commissioners' six-bucket framework.

The asset class with the second-largest net change during the quarter was mortgage loans. Life insurers collectively added $7.0 billion of such loans to their portfolios in the period.

David O'Malley, CEO of Penn Mutual Asset Management LLC, said if interest rates remain low, he would expect to see continued margin compression and a reach for yield into "non-traditional asset classes," like private loans and private asset finance transactions.

"The industry will continue to look for pockets of opportunity in a low rate, low return world," he said in an interview.

If equity markets continue to cooperate, companies should be able to manage the risks of low interest rates appropriately, Garofalo said. However, a material correction in the market combined with sustained low rates could cause life insurers to face potential reserve strengthening, lower earnings and lower sales, he said.

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