A continued low-interest-rate environment “poses a challenge” to insurance companies as they try to build capital and balance investment risks and returns, according to the first annual report on the industry, released Wednesday by the Treasury Department.
Life and health insurance providers may face more adverse consequences on profitability than property and casualty firms, the report concluded.
The aging of the U.S. population and increased life expectancy has increased demand for products, such as annuities, that offer lifetime income protection. But low rates make it more difficult to provide this.
Another risk from low rates is increased market exposure associated with the minimum guarantee provisions included in variable life and variable annuity products.
Low rates forced insurers to boost reserves in 2011, but as rates were more stable in 2012, insurers’ financial results were less affected, the report said.
But a sharp rise in rates could present threats, the study concluded. That would increase unrealized losses in fixed-income portfolios, and could also prompt policyholders to surrender contracts for higher yield elsewhere.
Some market experts are worried that long-term interest rates could spike if the Federal Reserve begins to reduce the rate of its asset purchases. Fed officials have said they may cut the size of the purchases later this year if the economy continues to improve.
Despite low rates, the life and health sector reported an aggregate net income of $40.9 billion in 2012. In the personal and casualty sector, net income was $37.3 billion, as the sector was hit by large insured losses from natural catastrophes.
The report said that catastrophe losses are estimated at $43 billion in 2012, just below the record estimate of $44.2 billion in 2011.
Going forward, the rising middle class in Asia and Latin America present growth opportunities for U.S. insurers.
The insurance industry is a major player in the derivatives market and the short-term funding market known as the tri-party repo market, two markets that are watched closely by regulators, the report said.
In 2012, the five largest U.S. insurers reported more than $1 trillion of combined notional amounts outstanding. Insurance companies remain significant participants in the repo market, although the level of activity has declined significantly since the 2008 financial crisis. Some economists warn that the repo market remains a risk to the financial system.
Insurers have historically been regulated by states. But in the wake of the financial crisis, when Treasury provided funds to two insurance firms, Congress established the Federal Insurance Office at Treasury to monitor the industry and report its findings to Congress.
To help prevent another financial crisis, the Dodd-Frank law also allowed regulators to designate insurance companies as “systemically important” to the financial system.
Earlier this month, Prudential Financial Inc. and American International Group Inc. said that they are likely to get this label.
This will place the firms under the oversight of the Fed and require them to hold more capital.
Other firms, like MetLife, are fighting not to be named as systemically important.