2008 was among the worst in memory for life insurers’ operating performance—the key drivers being substantial realized and unrealized losses on investment portfolios, higher costs of capital and a declining revenue base. These trends clearly are continuing and could deepen well into 2009 and beyond. A.M. Best Co.’s recently issued special report, “Life/Annuity Review & Preview 2009: U.S. Life Insurers Hunker Down As Market Turmoil Continues,” expresses the rating agency’s current perspective on the industry.

On September 18, 2008, A.M. Best revised the outlook on the U.S. life/annuity segment to negative from stable, citing uncertainty in terms of the future direction of the economy, real estate values, interest rates, equity markets—both domestically and globally—and liquidity. Specific areas of emerging investment risk cited included a number of previously stable investment classes—commercial mortgages (both direct loans and securitizations), asset-backed securities (e.g., credit card receivables and auto loans), alternative investments (such as limited partnerships and hedge funds) as well as prime residential mortgage-backed securities. Moreover, continued weakness in the equity markets translated to reduced fees for asset-based products, raising the potential for DAC write-offs and increased hedging costs for writers of variable annuities and fixed-indexed products. The severe decline and volatility in the equity markets has caused capital strain for many life companies, especially the large variable annuity writers.

Since that time, macroeconomic conditions have continued to deteriorate and many of these predictions have come to fruition. A.M. Best has witnessed extraordinary steps taken by governments globally to combat this unprecedented economic downturn. Nevertheless, despite these efforts, uncertainty continues regarding the depth and duration of the lingering financial crisis. Recently, U.S. equity markets have again re-touched November 2008 bear market lows. Clearly, these negative macroeconomic factors are having an adverse impact on life insurers’ balance sheet strength and operating performance.

Over the last several months, A.M. Best has taken a number of negative rating actions in the life insurance sector, triggered primarily by investment concerns. A.M. Best expects the pace of these rating actions to accelerate as it reviews the year-end results for life and annuity companies. It is our expectation that a significant number of negative rating actions—including downgrades of issuer credit ratings (ICR) and financial strength ratings (FSR) as well as outlook revisions—will occur as a result of this review. A.M. Best has observed a number of disconcerting trends including:

* Escalating credit impairments and write-downs in investment portfolios
* High concentration of real-estate linked assets
* Significant levels of unrealized losses relative to capital
* Reduced levels of tangible equity and lower financial flexibility
* Write-offs of goodwill and DAC
* Weakened fixed charge coverage and higher financial leverage ratios
* Deterioration in earnings in core business lines
* High exposure to equity market volatility, translating into increases in variable annuity reserves and capital combined with declining fee income and assets under management
* Lower sales in certain product lines
* Higher levels of complexity in product design, capital structures and accounting treatment, which at times can mask true economic risks
* Pressure from non-insurance subsidiaries on the enterprise’s earnings and capital...

Business Wire: A.M. Best Special Report: Life Insurers Hunker Down as Market Turmoil Continues