Full-year 2007 results of the nation's 1,500 life, health and annuity insurers revealed the impact of the mortgage crisis on an industry that holds nearly $14 billion in real estate and more than $670 billion in mortgage-backed securities.
TheStreet.com
had predicted several months ago that the industry would have problems.
A $6.5 billion net realized gain on investments in 2006 turned to a $1.5 billion net realized loss in 2007.
Driving this $8 billion freefall was a $4 billion decline in net realized gains on real estate -- from $4.6 billion in 2006 to $608 million in 2007 -- and a $1.9 billion decline in net realized losses on mortgage-backed securities and other bonds. A $1.1 billion and $1.4 billion worsening of losses on derivatives and miscellaneous investments, respectively, also contributed to the decline.
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The net result on overall industry profits was a $4.7 billion, or 11%, decline -- from $41.4 billion in 2006 to $36.7 billion in 2007.
We spoke with Melissa Gannon, vice president of insurance and bank ratings for TheStreet.com Ratings, about the year-end results:
Q: The situation looks pretty grim with losses across nearly all of the asset classes. Were there any bright spots?A: Not many, but there were a couple. Realized gains on U.S. government bonds increased $1 billion, and gains on common stocks increased $300 million. We would expect positive results in these two asset classes for the foreseeable future, but we've already seen further deterioration in bond portfolios for the few insurers who have reported first-quarter results.
Prudential (PRU),
Hartford Financial Services (HIG),
MetLife (MET),
Principal Financial Group (PFG) and
Genworth Financial (GNW) have all announced major declines in first-quarter profits caused by investment losses.
Q: If investment gains were down $8 billion but overall profits down only $4.7 billion, what made up the difference?A: The difference was an increase in the underwriting business itself -- taking in premiums and paying out claims. Operating profits were up 7.8%, from $62.6 billion in 2006 to $67.5 billion in 2007. The $4.9 billion increase in operating profits is primarily attributed to a $5.2 billion increase in the net account values of variable life and annuity policies. Hartford Life Insurance Company, a unit of Hartford Financial Services, Sun Life Assurance Company of Canada, a unit of
Sun Life Financial (SLF), and Jackson National Life Insurance Company, a unit of Prudential, reported the largest increases in what are known as separate accounts.
Secondarily, the health insurance sector represented a $2.5 billion increase in profits despite a 10% increase in claims. Humana Insurance Company, a unit of
Humana (HUM), Metropolitan Life Insurance Company, a unit of
MetLife (MET), and Connecticut General Life Insurance Company, a unit of
Cigna (CI), showed the greatest increases in health insurance profits during 2007.
Finally, profits from the fixed annuity business increased $850 million.
On the flip side, profits in the life insurance sector fell $113 million, with policy surrenders up for the fourth consecutive year. In 2007, policy surrenders were up 12% to $305 billion from $272 billion in 2006. At the same time, life insurance premiums fell nearly $6 billion to $139 billion in 2007 from $145 billion in 2006.
Q: What does all this mean for the industry?A: It means that annuities are really driving growth in this industry. Whether you agree or disagree that annuities should be a part of any retirement portfolio, sales growth continues to be strong.
Variable annuities, more so than fixed annuities, are driving the growth. People find particularly attractive the guaranteed living benefit feature that many variable annuities offer now. The appeal is particularly strong during a volatile market, such as what we experienced in the last quarter of the year.
To put it in perspective, life insurers now hold $1.9 trillion in assets allocated to variable annuity contracts and variable life insurance policies. These are assets that fluctuate with the market and thus the underlying value of the policy. This number has grown by double-digit percentages in four of the last five years.
Q: Your team analyzes the financial strength of the industry. What are you seeing from that perspective?A: Overall, the industry is very strong. Although there have been some dips, capital and surplus have grown every year since we started analyzing the industry in 1993. Capital and surplus grew $16.6 billion in 2007, up 5.3% from $312 billion in 2006 to $329 billion in 2007.
At the same time, the asset valuation reserve, which is money set aside to absorb investment losses, hit an all-time high of $44.7 billion at the end of 2007. Companies add to this reserve from capital as the book value of their assets is marked to market.
A reflection of the deterioration of mortgage-backed securities, which we talked about earlier, is an increase in insurers' holdings of junk bonds.
Junk bond portfolios decreased in size every year starting in 2003 through 2006. However, 2007 results show a $4.6 billion increase, from $124 billion in 2006 to $129 billion. This is mostly due to downgrades from investment-grade status to junk. Holdings of BB-rated bonds (the highest class of junk) increased $4 billion while another approximately $4 billion was re-classified out of B-rated bonds to CCC, CC or C bonds (the lowest level of junk before default).
As the mortgage crisis continues, this trend will worsen. Nonetheless, the industry has the capital and reserves to absorb it.
Insurers' investment holdings are evaluated in the Investment Safety Index of our
Financial Strength Ratings.
In this index, companies are rewarded for holding safe investments such as government-guaranteed bonds, and penalized for holding riskier investments such as mortgages, non-investment grade bonds, and equities.
Q: What other aspects do you consider in your ratings?A: We also evaluate each company's capitalization, profitability, liquidity and operational stability. The ratings are reviewed each quarter as new information is released.
You can look up any rating for free at the
Insurers & HMOs Screener under the Portfolio & Tools tab on our Web site.
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