Insurers may benefit from investment losses due to high rates in the US.

Insurers may benefit from investment losses due to high rates in the US.

Insurers in the United States Stand to Reap Windfall from Rule Change on Reporting Interest Rate-Related Losses

Seattle, Aug 14 (ANBLE) – Some insurers operating in the United States stand to reap a windfall worth hundreds of millions of dollars from the relaxing of a 31-year-old rule on reporting interest rate-related losses, a ANBLE review of regulatory filings and interviews with executives and analysts show.

Regulators in the US have voted to change how insurers should recognize interest rate-related losses after the industry lobbied for the move. This regulatory change, which allows insurers to realize these losses over time rather than immediately, will free up cash that insurers can use to write new policies, invest in their business, or boost their share price through dividends and stock buybacks. According to the financial disclosures of insurers and analysts who cover them, this change is expected to benefit at least 23% of life insurers rated by credit ratings agency Fitch, up from 8% the previous year.

The scope and financial impact of this change, which would expire at the end of 2025 unless revisited, has been first reported here by ANBLE. The relaxation of this rule is particularly advantageous for insurers invested in long-term bonds, as these bonds, which were issued before the Federal Reserve raised interest rates by more than 5 percentage points over the last year, carry much lower rates. Insurers have incurred losses when selling these bonds.

Among the insurers that will benefit from this change are Prudential Financial, OneAmerica Financial Partners, Principal Financial, and Massachusetts Mutual Life Insurance Company, according to Fitch. Prudential, for example, would see a windfall worth more than $1.3 billion, compared to the $1.8 billion in net fixed income-related losses they recorded in 2022.

It’s worth noting that the change proposed by the National Association of Insurance Commissioners (NAIC) diverges from how banking regulators have approached the same issue. Banking regulators do not allow banks to defer interest rate-related losses, as they fear it could lead to excessive risk-taking, which was a contributing factor to the 2008 financial crisis.

The proposal made by NAIC has received criticism from some consumer advocates who believe that the rule change would encourage more insurers to take investment risks in order to generate higher returns. However, the NAIC argues that the change is in the interest of insurance policyholders, as it would make it easier for insurers to sell loss-making bonds and reinvest in higher-yielding ones, thereby boosting their financial health.

The American Council of Life Insurers (ACLI), a lobby group that pushed for the change, stated that their intention is to harmonize the treatment of interest rate-related losses and gains. According to existing rules, insurers with a positive interest rate maintenance reserves (IMR) realize the benefit over time, rather than immediately.

While insurers in the United States are regulated by individual states, the NAIC has announced that all states will automatically adopt the proposed change. In addition, the NAIC is considering a long-term tweak to the rules, as stated by insurers including Equitable Holdings and MetLife in their filings with the U.S. Securities and Exchange Commission (SEC).

Deferring Losses

Under the new regime, insurers will be allowed to amortize interest rate-related losses over time equivalent to 10% of their statutory surplus. The statutory surplus represents the difference between insurers’ assets and liabilities, and is the money that can be used to pay policyholders in unforeseen circumstances.

This change comes with safeguards. Insurers would have to maintain a risk-based capital ratio of at least 300% after adjustments to be allowed to defer interest rate-related losses. Prudential, for example, would have been able to reverse about $1.3 billion of the $1.8 billion in bond losses they incurred last year if the new rules had been in place.

The change in reporting rules would also increase Prudential’s risk-based capital ratio to 409% from 383%, as stated in the SEC filing. Staying close to the 400% threshold is a target many insurers seek to achieve to obtain a better credit rating.

While Prudential declined to comment further on the matter, other insurers such as MassMutual, OneAmerica, and Principal Financial, who have negative IMR balances, have also not commented on specific financial health gauges. However, MassMutual has disclosed a negative IMR balance of $611 million as of the first quarter of 2023.

Other insurers that do not have significant negative IMR balances believe that they would benefit from having more flexibility with their hedging programs when it comes to accepting losses. Unum Group, for instance, stated that the rule change would be helpful to ramp up their hedging program.

In conclusion, the regulatory change on reporting interest rate-related losses in the US insurance industry is expected to have a significant financial impact, allowing insurers to free up cash and boost their financial health. While the change has received criticism from consumer advocates, industry representatives argue that it will harmonize the treatment of interest rate-related losses and gains, benefiting both insurers and policyholders. Insurers invested in long-term bonds are expected to be particularly advantaged by this change. As insurers prepare to realize these losses over time, they can allocate their resources more efficiently, write new policies, and potentially increase returns for their shareholders.