"Silent Heart Attack" for Pensions Driven by Yields

[Parsad]

Pension plans are going to have a difficult time over the next few years.  I suspect this low yield environment is what will eventually lead to a hard market for property/casualty.  And probably difficult times for many life insurers over the next decade.  Cheers!

 

http://www.bloomberg.com/news/2010-09-14/company-pension-funds-in-u-s-falling-behind-payouts-amid-low-bond-yields.html

[Guest dealraker]

Parsad,

 

You buying Marsh, Willis, Brown and Brown, AJ Gallagher, or Aon?

[Parsad]

Nothing yet.  I think things will get tougher for insurers before they get better.  Many are too heavy in treasuries and will now pay the price.  Alot of them didn't think that interest rates could come down so far on the long end.  Their longer term risks are now mismatched.  As they start to lose money, the hard market will come.  Unlike W.R. Berkley, I don't see the hard market coming for at least another year or longer, unless we see large scale catastrophes.  This will be a long-term problem for insurers.  Cheers!

[SharperDingaan]

Keep in mind that a DB pension plan typically runs with a duration mismatch of between - 11 to -14 on its bond portfolio; & low yields have forceably increased the absolute size of that bond portfolio. A 400bp rise (inflation bite) would make the average DB plan look very different!

 

SD

[ExpectedValue]

Parsad,

 

You buying Marsh, Willis, Brown and Brown, AJ Gallagher, or Aon?

 

Out of the names you listed, I think WSH is probably best. They give you the most leveraged way to play a turn in the insurance market. Aon's most recent deal dilutes the impact of the insurance broker biz.

[beerbaron]

I agree that life insurers that did not match their liabilities with their assets in the past to boost profits will find the next years quite hard. But how about Life insurers with matched Assets/Liabilities... wouldn't they be able to get acceptable returns no matter the environment?

 

BeerBaron

[Smazz]

I'll be honest,

I thought alot of "other" insurers would have gone tits up already by this point but whats that saying about "staying solvent longer......"?

[ExpectedValue]

One thing to keep in mind is that previously, the ok yield environment helped insurers earn their way out of the soft market. If you look at insurers historically, over the last 35 years, only 5 years have been profitable for the underwriting arms. Most of the income over that period has come from their investing arms. In a way, insurers are like leveraged bond funds.

 

Now that yields have come down to historic lows, ROEs should compress. It will be interesting to see how insurers react. There are only a handful that have truly savvy investment arms so I wonder what the rest will do.

[Guest dealraker]

I'm only mentioning brokers not underwriters in that list above.

[beerbaron]

Look at the underwriting results of the mid 80's, the interest rates were much higher but the underwriting results were much poorer as well. As the interests continuously declined the insurers have improved their underwriting results to offset the decline. The process takes time but it does happen, look at how the insurers followed the S&P500 since the early 80's it basically followed it and the interests went from 19% to 0%.

 

I have also tried to investigate the Japan example as well, they have had 0% interest rates since the beginning of the 90's. But I could not quite find any studies or long term data on the Japan life industries. The only thing I could find out is that Japan life insurers had some kind of oligopoly where they can set rates by meeting with each other. Maybe someone with a Bloomberg terminal could get the charts of the main insurers to look at...

 

BeerBaron

[ExpectedValue]

I'm only mentioning brokers not underwriters in that list above.

 

Yeah, to me, brokers are the best way to go. They have high retention rates, generate healthy amounts of cash flow, and good ROIC (even in a soft market). If the market turns, they can benefit from multiple expansion and since they aren't really capital intensive their business is pretty resistant to inflation.

 

I just think Marsh and Aon probably diluted their operations (branching into consulting) a bit too much to make the soft market easier so Willis would be a better pick.

[Parsad]

I have also tried to investigate the Japan example as well, they have had 0% interest rates since the beginning of the 90's. But I could not quite find any studies or long term data on the Japan life industries. The only thing I could find out is that Japan life insurers had some kind of oligopoly where they can set rates by meeting with each other. Maybe someone with a Bloomberg terminal could get the charts of the main insurers to look at...

 

Japanese insurers suffered considerably during the mid-late 90's.  The demographics and types of policies written are also important.  Not everyone is going to face the same demographic collapse the Japanese did, with such a large percentage of the population supported by so few working taxpayers.  But the Japanese life insurers also wrote far fewer variable life policies unlike North American insurers who favored them...we are already seeing the initial effects of these policies. 

 

If we face any sort of prolonged low interest rate environment, the cost of these liabilities will be substantial.  Eventually insurers shrink certain types of business, increase premiums and lower benefits, so longer term it won't be as detrimental as they will adjust, but for a few years it will be painful.  Cheers!

[Carvel46]

Parsad: What do you mean by? "But the Japanese life insurers also wrote far fewer variable life policies unlike North American insurers who favored them...we are already seeing the initial effects of these policies." What are the effects on American life insurance companies of a high mix of variable life policies?

[Sea Island]

Parsad: What do you mean by? "But the Japanese life insurers also wrote far fewer variable life policies unlike North American insurers who favored them...we are already seeing the initial effects of these policies." What are the effects on American life insurance companies of a high mix of variable life policies?

 

I assume that he is referring to the fact that most of these policies were sold based on an investment return, before expenses, of

8%+ which isn't going to be the experience that most policy owners have. Consequently, the policies will not perform as designed and require cash infusions to support them and ultimately many of the policies will be lapsed as the policy owners will not be able to afford to maintain them,

[Guest dealraker]

When I look at the brokers I too find Willis' valuation and performance a stand out. 

 

Just want to go back to the time when I bought Hub (owned 40% by Fairfax) for 10 times earnings growing at 15% plus.  Cried when they sold it but that was (of course) best.

[Parsad]

I assume that he is referring to the fact that most of these policies were sold based on an investment return, before expenses, of

8%+ which isn't going to be the experience that most policy owners have. Consequently, the policies will not perform as designed and require cash infusions to support them and ultimately many of the policies will be lapsed as the policy owners will not be able to afford to maintain them,

 

Yes, that is what I meant.  Thanks SeaIsland.  Cheers!

[Carvel46]

Thanks, that's what I thought.

Some life insurance companies are selling no-lapse, variable universal life policies... pricing seems to vary widely.

A few companies have competitive pricing.

Anyone have thoughts on or experience with no-lapse VUL policies?

AAII.com had a decent article on VUL policies:

Variable Universal Life: Astute Management Required [it's behind a pay wall]

 

[Sea Island]

No lapse VUL = whole life?