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Interest rate headwinds to define Q2'16 results for life insurers

Analysts expect life insurers' second-quarter earnings toimprove on previous results, but operating conditions remain grim as companiesstruggle through a lower-for-even-longer rate environment.

Headwinds in asset management and pressure from regulatorychanges could also influence second-quarter earnings. "We see regulatorypressure on annuities and asset management while rate-sensitive [life]products, in decline for years, are unlikely to recover," Goldman Sachsequity analysts wrote in a July 15 report.

Treasury yields continued to flatten during the quarter,lowering insurers' investment income and narrowing the margins ofrate-sensitive products. Life insurers own sizable government bond holdings tofund guaranteed life policies and long-duration products, making themparticularly sensitive to drops in T-note yields.

Treasurys typically react to changes in the federal fundsrate, the baseline interest rate set by the Federal Open Market Committee. TheFOMC has committed to a near-zero funds rate for nearly eight years, butTreasury yields have fallen even further since the committee by 25 basis pointsin December 2015. The yield on the 10-year Treasury note hovered around 1.8% formost of the quarter before falling more steeply in May and June. On June 27, ithit 1.46%, a level not seen since mid-2012.

Insurance company management teams have tried to estimatethe impacts of unfavorable rates, but anticipating drops this severe has beendifficult, Yaron Kinar, a research analyst at Deutsche Bank, said in aninterview. Insurers often use a 2% yield environment in stress tests, heexplained, but "right now, 2% yield is almost a blue-sky scenario."

The record lows reached in early July would impactresults later in the year, he said, but the sub-2% rates seen throughout thesecond quarter are still worse than a year ago. Kinar expects insurers'alternative investment earnings to improve sequentially from the first quarterbut fall compared with the second quarter of 2015.

A survey of analyst expectations shows a comparatively rosypicture. Analysts expect seven of the 10 largest life insurers ranked by total equityto report better earnings than either the year-ago period or the prior quarter.Those estimates reflect the mean analyst recommendations for each stock astracked by S&P Capital IQ.

and Lincoln National Corp.face greater rate exposure than others because their product mix leans more onguaranteed products and annuities, making for a tougher year-over-yearcomparison, Kinar said. During the second quarter of 2015, the 10-year noterose from about 1.80% to above 2.30%.

CathySeifert, an insurance equity analyst for S&P Global, characterized the lowrate environment as more of a stabilized pressure on life insurers. Thequestion now, she said in an interview, is "can they sustainoperating margins at these levels, given this latest downward pressure onrates, or does this take them another step down?"

Seifertnoted that an improved employment picture could help offset the negativeoverhang from interest rates for insurers with a product mix geared towardworksite products. UnumGroup, one of the largest long-term disability writers, could seebetter underwriting results connected to the strong job gains in and . On the other hand, May's jobsreport was one of the worst in years.

Unumalso operates a relatively large U.K. business, which raises its exposure tofallout from the U.K.'s decisionto leave the European Union, Goldman Sachs analysts wrote. Theanalysts downgraded Unum to "sell," citing a weaker British poundthat could lessen earnings contributions from the U.K. unit, as well as slowerGDP growth there, which could harm organic growth and create higher loss ratios.

Somecompanies may use this quarter's results as an opportunity to exit or downsizelines of business, Seifert added. "To varying degrees, just about everycompany in the space is either buying or selling something," she said. "Ithink the one thing to look for this quarter is corporate actions."

Manyof the books for sale are annuities assets and other spreads-based businessesthat may be particularly attractive to private companies that operate withoutthe added pressure of shareholder demands, Seifert said. Mutual insurers couldbe on the lookout for those assets to build scale, and they are likely to beoffered at a discount to book value, she added.

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