Moody’s examines inflation’s impact on U.S. insurers

Inflation and interest rates have been moving higher, a benefit for insurers, says Moody’s Investors Service. Although the benefits of current inflation levels outweigh the negatives, for now, the firm’s most recent sector commentary examines some of the risks which could affect U.S. life insurers.

In their commentary, Inflation: Rising interest rates, higher wages buoy top-line growth, Moody’s researchers say bond yields and investment income are rising and spread-based product margins are widening. Wage inflation, interestingly, is also seen as a positive for life insurers, as it helps to boost life insurance purchases.

On the negative side, they say inflation is weighing on bond and equity valuations. “For life insurers, however, the benefits of current inflation levels outweigh the negatives for now,” they write.

In short, they say with roughly 70 per cent of the industry’s investments in fixed income, insurers are starting to see their net investment income rise. “In Q1 2022, yields on new investments finally exceeded life insurers’ average portfolio yields, for some insurers, stemming the decades-long erosion of their investment returns,” they write.

Wage inflation has also led to increased consumer spending, particularly in group benefit and retirement products, although they say this is likely to subside over time. For now, however, they say many group pension providers have seen employee retirement plan deposits grow, alongside increased employer matching. Benefits providers have been selling more group insurance as well, often with larger face amounts. Corporate-owned life insurance has also been selling well.

In looking at the other side of things, they point out that investor concerns over uncontrolled inflation and the risk of a recession have led to a drop in equity values and bond prices since the beginning of 2022, hurting the profitability of equity market-based variable annuities and retirement savings plans. They also say the salaries of insurers' own employees are also rising.

The report also discusses the possibility of spiking inflation numbers and stagflation. “While not our baseline scenario, a sharp, persistent spike in long-term bond yields (for example, over 300 basis points) could precipitate elevated policy surrenders of interest-sensitive life insurance and annuity contracts out of their surrender charge periods, pressuring liquidity and regulatory capital,” they write. Stagflation, meanwhile, would also hurt insurers, “reversing sales and revenue growth and earnings expansion, and heightening default and credit risk.” 

They add that continuing economic growth, even if it is slowing, is the key to continued industry revenue and profit growth. Among the risks which could derail the firm’s economic expectations, they say commodity prices, supply chain disruptions, and a larger than expected economic slowdown in China, or monetary missteps by central banks resulting in a recession, could all impact Moody’s outlook.

“High inflation plus a recession or stagflation would create an even harsher result, causing unemployment to rise, which would depress life insurance purchases and reverse life insurers’ top and bottom line growth. In a weakening economy, corporate defaults and credit losses in insurers’ investment portfolios would also rise and regulatory capital levels would fall,” they write. “Although these are not our baseline scenarios, they are very real risks for the life insurance industry.”