Stable rating for life industry: A.M. Best

By Kate McCaffery | October 21 2014 09:00AM

Conditions are reasonably good for insurance companies right now, and company behaviour is also quite good from a risk-management standpoint, leading ratings agency, A.M. Best Company, to say their industry outlook is a stable one for the life and health industry in Canada.A recent special report from A.M. Best discusses current economic conditions – everything from projected GDP growth, to domestic real estate valuations, and global interest rates, and provides a very thorough primer on the regulatory pressures that are causing companies to act in certain ways, and how the companies themselves are responding.

Among the economic conditions creating demand for financial product companies, are low global interest rates. “Demand remains high, as investors seek safe assets in the face of geopolitical risks,” say the report’s authors. At the same time, insurance companies remain cautious:

“Canadian life insurers’ capital-management strategies have been focused on preserving capital, lowering financing costs and reducing volatility,” they say. “Uncertainty surrounding regulatory accounting, actuarial and solvency changes have also forced companies into a holding pattern strategy. Many are waiting to see what final regulatory changes will be, and how these may impact their business, before deploying capital to shareholders, or allocating significant amounts of it to new lines of business.”

Product pricing remains competitive, but generally rational.

– A.M. Best

A.M. Best notes the life industry’s overall profitability increased in 2013, for the third straight year, thanks to market returns, better credit conditions, and executive decisions about product pricing and company focus.

Among the economic good points companies have to work with, are contained inflation numbers, and forecasts calling for modest GDP growth in the Canadian economy, through 2016. Growth in domestic business and overseas markets have also resulted in direct premium increases last year, for the second year in a row.

Potential economic rough spots, on the other hand, include Canada’s close ties to the U.S. economic recovery and expansion.

“With 75.8 per cent of exports going to, and 52.1 per cent of imports coming from the United States, continued Canadian growth will be linked strongly to the ongoing U.S. recovery and expansion.”

The firm also notes that sluggish sales of certain product, and underperforming legacy blocks of business could add volatility to earnings in the future. “Any return to greater volatility,” they write, “likely driven by elevated global risk, would test the life insurers’ ability to maintain recent improved results.”

The biggest weight on results, however, would appear to be the holding pattern companies have adopted, while waiting to see how the industry’s varied and numerous regulatory changes will play out in the future.

In the meantime, company focus on growing assets under management, on wealth management services in general, on reducing leverage, and refinancing existing debt loads, all bode well for industry ratings.

Companies have also increased hedging, as part of larger efforts to de-risk their products. This “risk-focused decision making by management,” and expense control, coupled with reinvestment in strategic, “chosen growth areas” (again, namely in wealth management), “have also been positive rating factors for the industry.”

“Product pricing remains competitive, but generally rational,” the analysts note. “The Canadian life industry has benefited from economic factors...It also achieved results through a combination of self-directed action, such as a continuing strategy of re-pricing products, a changing product mix, and a greater focus on fee-based income.”

Their investment strategies, meanwhile, have not involved wholesale investment strategy changes, or a slide into alternative investments, “which are viewed as a way of generating returns that are independent of traditional equity and fixed-income products.” Instead, they say corporate bonds account for the largest segment of bond portfolios, as companies look for higher yields than those offered by government and provincial bonds. Mortgage loans, the vast majority of which are commercial in nature, are also being used to provide better yields. (Analysts say there continues to be concern about the increased debt load carried by Canadian households, and for possible overvaluation in some residential markets.)

In short, the report paints a picture of an industry that is well-capitalized, and managing carefully. Analysts expect financial leverage to continue declining in the near term. Moreover, the report’s authors suggest stockpiled positions of excess capital will also come down slowly, as regulators provide clarity about their future requirements.