Variable annuities, which are tax-advantaged investments that once fueled profits at life insurance companies, are starting to drag profits as the stock market declines. This recent activity is the result of insurers taking losses on the massive investment portfolios that back their insurance policies. A large number of the losses have come from holdings in the financial sector, including Lehman Brothers securities, and from falling values in some mortgage-backed securities.
Insurance companies have also been hit hard with billions of dollars in unrealized losses as investment-grade corporate bonds have all suffered big declines in recent weeks. Since the stock market has dropped, insurers are facing reduced fee revenue as their annuity assets under management decrease. In the past four weeks, the Dow Jones Life Insurance Index has dropped 47 percent, while there was a 26 percent drop in the DJIA during the same period.
According to Morgan Stanley analyst Nigel Dally, he expects “the most challenging quarter for the life insurers in many years.”
Lincoln National Corp. was the last insurer to state that its retirement business will negatively impact its third-quarter earnings. A 10 percent drop from the same quarter last year in retail deposits into its retirement and insurance products was reported by Lincoln National.
An increase in cost to insurers is also being caused by a popular innovation in variable annuities. Insurance companies created hedging programs to manage the risk of market volatility associated with the minimum-income guarantees that many annuities carry. The cost of hedges have greatly increased during this market volatility, which is cutting into insurance companies’ profit margins, explained Fred Crawford, Lincoln National’s chief financial officer in an interview on Friday, October 10, 2008. Crawford also stated that the company’s fixed annuities, which offer a minimum interest rate to the investor, have recently performed better.
Last Friday, Standard & Poor’s revised its outlook on the life-insurance sector to “negative” from “stable” on higher credit losses, lower fee-based revenues and reduced financial flexibility.