Economic Climate Adversely Affecting Life Insurers’ Financial Performance, According to Towers Perrin Study

Hedging Programs Continue to Be Viewed as “Weapon of Choice” for Market Risk; CFOs Wary of Second Quarter Growth Outlook for Premium, Revenue and Net Income

STAMFORD, CT, August 17, 2009 – The sluggish economy is negatively impacting insurers’ financial performance and altering their investment and product strategies — particularly around asset/liability management (ALM) and hedging for variable annuities (VA) — according to data from the latest Towers Perrin survey, ALM and Hedging in Light of the Economic Crisis.

A vast majority (70%) of North America life insurance company chief financial officers (CFOs) surveyed indicated that depressed market values on fixed-income securities will adversely impact their company’s financial performance over the next 12 to 24 months, and more than 20% reported that the impact will be significant. The two areas that CFOs see as most affected by the financial climate are capital and surplus (80%) and their company’s balance sheet (76%)

CFOs further asserted that the economic crisis has significantly impacted their firms’ investment and product strategies. Nearly 60% of respondents have increased their analysis of risky asset classes while reducing their asset purchases to hold more cash. Additionally, 41% of the firms have eliminated riskier asset classes from their portfolios.

“Despite emerging signs of an economic recovery, we are still very much deep in a recession that began last year, and should expect more defaults in 2009 and at least part of 2010,” said Jack Gibson, Managing Principal and Leader of Towers Perrin’s Americas Life Insurance Practice. “Given the elevated levels of unrealized losses in life insurers’ asset portfolios, more strain on capital is inevitable.”

The majority of respondents (53%) indicated credit risk as the largest market risk exposure their firms are facing — more than double that for equity risk or interest-rate risk. Still, the majority of companies are not hedging credit risk, as only 13% of CFOs said they are focusing on hedging this risk. Rather, 100% said the focus of the company’s hedging program is equity market risk; 60% cited volatility risk, and 53% indicated the focus is on interest-rate risk.

Additionally, more than two-thirds of CFOs surveyed (67%) pointed to credit spread risk and interest-rate risk as major challenges in managing asset/liability risks. The overwhelming majority (94%) are managing credit risk by constraining their investment policy to limit the amount/percentage of assets that may be held in each credit category.

“While these companies are closely managing their credit spread and interest-rate risks, the tools and techniques these firms are using have not changed much since the late 1980s and early 1990s, when they were first used in the market,” said Hubert Mueller, Towers Perrin Principal and Survey Leader. “I think there needs to be a new way of looking at how to manage some of these risks — particularly credit risks — where many companies were severely hit over the past year.”

Based on the survey results, it appears that hedging programs have survived extensive scrutiny from both third parties and company boards, and appear to be the “weapon of choice” to combat market risk. Sixty-seven percent of the CFOs queried said they were satisfied with their companies’ hedging programs; 27% said they were highly satisfied. Conversely, only 6% expressed dissatisfaction with hedging programs.

“Insurers seem to have reset their expectations for hedging programs as a consequence of the financial crisis,” said Dave Czernicki, Towers Perrin Senior Consultant. “Companies have seen first hand that, without a sufficient hedging program in place, the situation could have been far worse. There have still been some issues associated with hedging programs — most notably increased basis risk, market illiquidity and increased transactional costs.”

Premiums, Revenue and Net Income Results Up in Second Quarter, but Still Lagging

Life insurance CFOs were still wary regarding second quarter results. The majority of respondents believe that generally accepted accounting principles (GAAP) net revenue and GAAP net income will stay the same or decline compared to the same quarter last year.

Fifty-two percent of respondents predicted growth in new life and annuity premiums over the same quarter last year, while 20% predicted a decrease. Over one-third (35%) of respondents said they expect first quarter GAAP net revenue to increase over the same quarter last year, while 34% predicted a decline. Finally, 31% said GAAP net income would increase compared to the same quarter last year, versus 39% who predicted a decrease.

Further, Towers Perrin’s growth indices (based on the weighted average of survey responses) summarizing respondents’ year-over-year growth outlook, saw an increase in the second quarter of 2009, but still remained below historic levels. Values between 97 and 103 are taken to be basically no growth. The premium index rose to 104 from 101; the GAAP net revenue index increased to 100 from 97, and the GAAP net income rose to 98 from 95.

“Two of our three growth indices remain in the ‘no growth’ area, with modest growth predicted for premiums,” said Mr. Gibson. “We take this to reflect that market conditions will remain challenging, but these indices are slowly beginning to recover.”

Among other key survey findings:

  • 47% of respondents said their companies are changing risk limits in their hedging program, while 60% are making changes to product prices and/or design features.
  • 61% of respondents asserted that they expect credit spreads to decrease moderately or significantly through the end of 2009.
  • 88% of CFOs surveyed said they expect treasury rates to increase moderately or significantly by year’s end.

About the Survey

Twenty-seven CFOs participated in the Web-based survey, which focused on key issues relating to ALM and VA (and other) hedging in light of the current economic crisis. It also explored CFOs’ expectations for second quarter 2009 results. The survey, conducted from May 19, 2009 through June 9, 2009, primarily included CFOs from large and midsize North American life insurance companies; 64% had assets of $5 billion or more, and 15% were multinationals.

About Towers Perrin

Towers Perrin is a global professional services firm that helps organizations improve performance through effective people, risk and financial management. The firm provides innovative solutions in the areas of human capital strategy, program design and management, and in the areas of risk and capital management, insurance and reinsurance intermediary services, and actuarial consulting. Towers Perrin has offices and alliance partners in the United States, Canada, Europe, Asia, Latin America, South Africa, Australia, New Zealand and the Middle East. More information about Towers Perrin is available at

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