Insight: Insurers poised for US break on investment losses from high rates

Principal Financial

14/08/2023 11:00

By Koh Gui Qing
       SEATTLE, Aug 14 (Reuters) - Some insurers operating in
the United States stand to reap a windfall worth hundreds of
millions of dollars from the relaxing of a 31-year-old rule on
reporting interest rate-related losses, a Reuters review of
regulatory filings and interviews with executives and analysts
show. 
    U.S. regulators who met in Seattle on Sunday voted to change
how insurers should recognize these losses after the industry
lobbied for the move. 
    The change, whose scope and financial impact are first
reported here, will free up cash which insurers can use to write
new policies, invest in their business, or boost their share
price through dividends and stock buybacks, according to their
financial disclosures and analysts who cover them. 
    At least 23% of life insurers rated by credit ratings agency
Fitch stand to benefit, because their interest rate maintenance
reserves (IMR), which reflect gains or losses from interest rate
changes, were negative as of the end of December. That is up
from 8% a year earlier. A negative IMR forces insurers to tap
pots of money they would have otherwise spent on their business
or returned to shareholders. 
    The change, which would expire at the end of 2025 unless
revisited, will allow insurers to realize some of these losses
over time, rather than straight away, according to a draft of
the proposal released by the National Association of Insurance
Commissioners (NAIC).
    The Reuters review, which included a search of the public
filings of all insurers listed in the stock market as well as
those rated by credit ratings agencies, shows the changes will
be particularly advantageous for firms invested in long-term
bonds. This is because bonds that were issued before the Federal
Reserve raised interest rates more than 5 percentage points over
the last year carry much lower rates, and insurers incurred
losses when they sell them.
    Among those insurers are Prudential Financial  PRU.N ,
OneAmerica Financial Partners, Principal Financial  PFG.O  and
Massachusetts Mutual Life Insurance Company, according to Fitch.
In the case of Prudential, the reprieve would be worth more than
$1.3 billion, according to the company's disclosures. That
compares to $1.8 billion in net fixed income-related losses
Prudential recorded in 2022.
    The NAIC's move diverges with how banking regulators have
approached the same issue. They do not give banks the option of
deferring interest rate-related losses, fearing excesses that
led to the 2008 financial crisis. Such losses were behind the
collapse of major regional banks this year, including Silicon
Valley Bank and First Republic Bank.
    Some consumer advocates have criticized the NAIC for going
ahead with the proposal. Edward Stone, a lawyer who has
represented policyholders in cases where troubled insurance
companies were liquidated, said the rule change would encourage
more insurers to risk investment losses in order to juice
returns.
   "Insurance companies, for decades, have been trying to kick
the can down the road. This is just another attempt by them to
say we should get some sort of favorable accounting treatment,"
Stone said.
    An NAIC spokesperson said the change is in the interest of
insurance policyholders, because they would make it easier for
insurers to sell loss-making bonds to re-invest in
higher-yielding ones, boosting their financial health.
    A representative for the American Council of Life Insurers
(ACLI), a lobby group that pushed for the change, said its
intention is to harmonize the treatment of interest rate-related
losses and gains. Under existing rules, insurers with a positive
IMR realize the benefit over time, rather than immediately.
    Insurers in the United States are regulated by individual
states rather than the federal government, but the NAIC has said
that all states will automatically adopt the change it backs.
While the change sunsets in 2025, the NAIC is also considering a
long-term tweak to the rules, insurers including Equitable
Holdings  EQH.N  and MetLife   MET.N  have said in filings with
the U.S. Securities and Exchange Commission (SEC). 
    
    DEFERRING LOSSES
    Following the rule change, insurers will be allowed to
amortize interest rate-related losses over time equivalent to
10% of their statutory surplus. The statutory surplus is the
difference between insurers' assets and liabilities, money that
can be used to pay policyholders in unforeseen circumstances. 
    The new regime has some safeguards. A key metric of an
insurer's financial health, its risk-based capital ratio, would
have to be at least 300% after adjustments to be allowed to
defer interest rate-related losses.
    Prudential would have been able to reverse about $1.3
billion of $1.8 billion in bond losses last year had the new
rules been in place, Chief Financial Officer Ken Tanji told
analysts on the company's second-quarter earnings call. 
    The change will also increase Prudential's risk-based
capital ratio to 409% from 383%, according to an SEC filing.
Staying close to the 400% threshold is a target many insurers
seek to achieve a better credit rating.
    A Prudential spokesperson declined to comment beyond Tanji's
remarks.
    A spokesperson for MassMutual, which along with Prudential,
OneAmerica, and Principal Financial ranks among the insurers
rated by Fitch that have the largest negative IMR balances,
declined to comment on gauges of the company's financial
strength, such as its risk-based capital ratio. The spokesperson
would only say that MassMutual had a negative IMR balance of
$611 million as of the first quarter of 2023.
    OneAmerica declined to comment, while Principal Financial
did not respond to requests for comment.
    Some insurers that do not carry large negative IMR balances
also say they would benefit from having room to take more risk
when hedging interest rates. Unum Group  UNM.N , which has "very
little" negative IMR, would see little immediate financial
impact from the change but would be able to be more flexible
with its hedging program when it comes to accepting losses,
chief financial officer Steven Zabel told analysts on August 2.
    "That would be helpful to really ramp up the hedging program
a little bit more," Zabel said.

 (Reporting by Koh Gui Qing in Seattle
Additional reporting by David French in New York; Editing by
Greg Roumeliotis and Anna Driver)
 ((guiqing.koh@thomsonreuters.com; +1 646 223 6033;))