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Lifecos overcame premium pressure to post strong Q3 statutory profitability

Just as the U.S. life insurance industry's second-quarter statutory operating results were not as bad as they appeared at first glance, its third-quarter financials are not necessarily as historically strong as they might otherwise seem.

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Pretax operating income of $23.14 billion for the U.S.-domiciled life and health insurance companies that file publicly available quarterly statements with the NAIC for the period represented the industry's highest such result since the first quarter of 2012 and marked an increase of 80.9% from what had been a challenging year-ago quarter. The improvement occurred even as life insurers continued to deal with broad challenges associated with the low-for-long interest rate environment and faced topline pressure from slumping sales of variable annuities ahead of what had been the expected implementation of the fiduciary rule by the U.S. Department of Labor.

Net premiums and annuity considerations fell 4.7% year over year in part as a result of relatively flat direct premiums in combination with lower assumed premiums and higher ceded premiums. But total revenue increased 2.7% as net investment income earned increased and the negative income statement entry for the reserve adjustment on ceded reinsurance narrowed sharply. The amount of increase in the aggregate reserve on life and accident-and-health contracts fell to $33.97 billion from $42.09 billion in the third quarter of 2015.

The nature of the year-over-year comparisons for the first nine months of 2016 was far less dramatic. The U.S. life industry generated pretax operating income of $35.89 billion for that year-to-date period, up from $34.53 billion in the first three quarters of 2015. Net income, which soared to $17.58 billion in the third quarter from just $2 billion in the year-earlier period, declined year-to-date to $18.62 billion from $26.36 billion in large measure due to the $6.01 billion of net realized capital losses sustained by the industry during the first nine months of 2016.

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Four individual entities recorded improvement in pretax operating income of $1 billion or more year over year during the third quarter. Most notable among them was Prudential Financial Inc. unit Prudential Annuities Life Assurance Corp., whose third-quarter pretax operating income rose to $4.17 billion from $69.7 million in the year-earlier period. It was a second consecutive quarter of extraordinary results for Prudential Annuities Life, which had a pretax operating loss of $6.99 billion for the three-month period ended June 30.

The second quarter's result followed a series of transactions within the Prudential group whereby select entities recaptured and/or reinsured risks related to variable annuity living benefit riders that had previously been reinsured by an affiliated captive whose financials are outside of the scope of the statutory data collected by S&P Global Market Intelligence. Prudential Annuities Life attributed a favorable comparison in its third-quarter GAAP financials in an SEC filing to changes in its estimate of total gross profits as a result of the implementation of a new asset-liability matching strategy during the period.

Given the unusual variability in Prudential Annuities Life's recent results and the lack of availability of results attributable to Prudential Legacy Insurance Co. of New Jersey, a Garden State-domiciled company whose quarterly statements are not released to the public by statute, this article presents U.S. life industry results both including and excluding the Prudential life group where relevant.

From a pretax operating income perspective, the industry aside from Prudential produced a profit of $18.06 billion during the third quarter, up from $3.11 billion in the year-earlier period. Net premiums and considerations on that basis fell more than 7% year over year, and the reduction in the increase in the aggregate reserve was more muted as it narrowed to $36.17 billion from $40.49 billion.

The U.S. life units of MetLife Inc., Manulife Financial Corp. and AEGON NV, as well as the group led by Jackson National Life Insurance Co., joined the Prudential life group in showing improvement in pretax operating income of $1 billion or more during the third quarter from operating losses for four of those five groups in the year-earlier period.

Not all the comparisons were favorable, however.

The group led by Northwestern Mutual Life Insurance Co. produced a pretax operating loss of just less than $180 million during the third quarter as compared with a profit of $125.5 million in the year-earlier period. It marked only the second pretax operating loss for the group in the past 27 quarters. The increase in aggregate reserve of $2.42 billion was $211.8 million above the figure attributable to the third quarter of 2015. The group remained well into the black for the first nine months of 2016, however, with pretax operating income of $323.2 million.

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Its net loss for the quarter was considerably smaller at less than $51.9 million as it incorporated an income tax benefit of $147.1 million, offset in part by $19 million in net realized capital losses. Northwestern Mutual posted a tax benefit for full year 2015, reflecting the impact of low-income housing tax credits and other tax credits as offsets to tax payable on ordinary income.

The U.S. life units of Athene Holding Ltd. had the industry's largest year-over-year decline in pretax operating income. Growth in the increase in aggregate reserve at Athene Annuity & Life Co. exceeded the company's rapid expansion in premiums and considerations during the quarter, which largely reflected strength in ordinary individual annuities. The company discussed the traction its new indexed annuity and multiyear guaranteed annuity products had achieved in the marketplace in the run-up to its recent initial public offering.

Those declines were the exception rather than the rule, however, as only two other U.S. life groups or stand-alone entities produced year-over-year deterioration in pretax operating income of $100 million or more during the third quarter: Allianz Group and Munich American Reassurance Co. A total of 24 groups and top-tier entities generated improvement in pretax operating income of $100 million or more year over year.

Sentiment around the life industry has improved markedly since the third quarter's end, not due to the nature of the financial results for the period but rather because of fallout from the surprise outcome of the U.S. presidential election. The 10-year Treasury yield, which ended September at 1.61%, recently topped 2.50% for the first time in more than two years, and President-elect Donald Trump's selection of Andy Puzder to serve as labor secretary has fueled speculation as to whether the fiduciary rule will be implemented as planned in April 2017.

The LIMRA Secure Retirement Institute observed a significant drop in sales by independent broker/dealers and sluggishness in carriers' introduction of new products ahead of the fiduciary rule's scheduled implementation as it reported a 21% decline in variable annuity sales and an 11% retreat in overall annuity sales during the third quarter. Direct ordinary individual annuity considerations were down 11.1% in the quarter, according to a review of disclosures in quarterly statements, in what represented the largest year-over-year retreat since the third quarter of 2012.

The potential timing and nature of positive developments on the regulatory front remain somewhat speculative, however, and it could take time for higher interest rates to meaningfully benefit life industry results. Net yields on invested assets remained at or near historical lows during the third quarter as measured on trailing-12-months and annualized bases.