The Best’s Special Report, “Rising Interest Rates Suppress Debt Appetite for Life/Annuity Insurers,” states that the prolonged low interest rate environment and cheap capital has allowed L/A insurers to strengthen their balance sheets by replacing higher-cost debt with significantly lower-cost alternatives over the last five to 10 years. However, this a scenario may be coming to an end as the 18 publicly traded U.S L/A companies followed for this report kept their appetite for long-term debt in check in 2022.

“Many insurers have already taken advantage of lower financing costs to pay down their near-term debt maturities and are now taking a wait-and-see approach with respect to interest rates, particularly with yield curve inversions occurring,” said Jason Hopper, associate director, industry research and analytics, AM Best.

Total debt and notes payable increased slightly from year-end 2021 through the third quarter of 2022, with long-term debt rising marginally by 1% owing to a handful of more-frequent issuing companies. However, there have been notable declines in capital at many companies on a GAAP basis due to the accounting impact of rising interest rates, which has led to large unrealized losses on fixed income portfolios from the reduction in bond values. This in turn has led to higher financial leverage, or long-term debt to adjusted shareholders’ equity, ratios, with the industry aggregate climbing by more than 20 percentage points, to 42.5%, in the third quarter of 2022 from year-end 2021. Furthermore, the number of companies with ratio over 33% in 2022 tripled from year-end 2021 to more than half.

Despite the increase in leverage, interest coverage remains healthy for L/A insurers. More than 40% of companies at year-end 2021 had an interest coverage ratio that is greater than 10 times earnings before interest and taxes. Earnings have varied for three quarters throughout the year, and macro-economic challenges, including inflation and capital market volatility, are expected to reduce profitability compared with prior years. In addition, the decreased value of bond holdings has resulted in unrealized losses on fixed maturities. However, the life industry follows a hold-to-maturity investment strategy, and therefore, the unrealized losses and hit to capital only become permanent if those assets are sold at the current discounted market value price, realizing those losses.

“Uncertainty about the direction and pace of interest rate changes further demonstrates the need for a strong asset-liability matching program and routine rigorous stress testing of insurers’ investment portfolios and liquidity positions,” said Hopper.

To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=327755.

AM Best is a global credit rating agency, news publisher and data analytics provider specializing in the insurance industry. Headquartered in the United States, the company does business in over 100 countries with regional offices in New York, London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City. For more information, visit www.ambest.com.

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