U.S. Life Insurer RBC Trends Confirm Industry Capital Levels Remains Strong

Industry capitalization trends remained relatively stable in 2022?- Our annual review of U.S. Life Insurer regulatory risk based capital (RBC) ratios indicates capitalization for the industry remained stable during 2022 for the fifth straight year.??That said, we saw a significant up-tick in the number of companies that saw their RBCs decline year-over-year, a trend that was present in three of the last five years.??However, capital levels overall remained strong in what we would consider to be the A+/AA range and demonstrate the ability of life insurers to successfully navigate through a mix of challenges over the past few years including the COVID-19 pandemic, volatile equity markets and until the past month, rising interest rates.??It is important to emphasize the RBC ratio is only one metric, and the purpose of our study was to look at overall industry directional trends versus focus on any particular insurer’s ratio.

An important distinction of the RBC ratio is that it is calculated using statutory accounting principles (SAP) and not GAAP, and as of yet, it is not formally reported on a combined/consolidated basis.??In addition, we have found it is still heavily influenced by investment quality which we estimate determines about two-thirds of the RBC ratio.??Unfortunately, the billions of dollars in losses some insurers have incurred over the past decade strengthening reserves for legacy liability blocks of long-term care, variable annuities and guaranteed universal life, could suggest that it may be within their policy liabilities and underwriting assumptions, and not their investment portfolios, where the greatest risks on some life insurers’ balance sheets lie.

We examined RBC trends for 80 insurance groups split between public & private stock-owned, mutuals and reinsurers.??We estimate year-end 2022 average group RBC levels of:??mutuals – 514%; private-stock owned – 465%; public stock-owned – 415%; and reinsurers 298%.??For the year, 51 insurers saw their RBCs decline versus increases for 28, which was a reversal from 2021 when year-over-year increases in 50 ratios compared with declines for 30.

Private Equity owned insurers in general continue to appear well capitalized - The past several years has seen a wave of new private equity ownership enter the U.S. life insurance industry, raising potential concerns by both consumer groups and regulators as to how acquired companies might be capitalized going forward. Specifically, the concern we have heard expressed that privately owned insurers might be de-capitalized in order to generate higher ROEs and thereby potentially put policyholders at greater risk. This does not appear to be supported by the RBC trends we observed which suggests that on average, their capital positions remain quite strong.?? Rather, it appears to be the publicly traded insurers that are feeling some downward pressures on their capital ratios.?

Life insurers not facing the risk from unrealized investment losses that have impacted banks -?The recent crisis in the banking crisis has also turned the spotlight on unrealized investments losses on life insurers fixed income investments.??We estimate these have flipped from an unrealized gain in the 8-10% range at year-end 2021 to a similar sized loss as of year-end 2022.??However, this change is almost entirely attributable to the rise in interest rates as exposure to below investment grade bonds has remained very stable for the past five years at about 5.5% of fixed income or 4.0% of total investment portfolios.??

Unlike banks which may need to sell their investments to fund on demand withdrawals by depositors, such as what happened with Silicon Valley Bank, or a property/casualty insurer that might conceivably have to do so to fund a large catastrophe loss, life insurer policy liabilities, with the possible exception of fixed annuities are either very illiquid or in the case of term or group life for example, have no surrender value.??Even for policy loans on whole life and universal life, insurers have up to six months to advance funds.??The bottom line is this means life insurers can hold fatheir fixed income securities to maturity and see them redeemed at par.??Thereby making both unrealized losses, and gains for that matter, largely irrelevant when assessing their financial strength.

For those unfamiliar with the RBC ratio -?It is just?one tool used by State insurance regulators to assess a life insurer’s capital strength?and level of risk inherent in its business.??The RBC formula applies prescribed factors for various risk elements of a life insurer's business to ascertain a minimum capital requirement proportional to the amount of risks assumed.??These include risks attributable to investments, underwriting experience, interest rates and other business expenses. The factors are higher for items deemed to have greater underlying risk and lower for those deemed to have less.??The RBC can trigger specific regulatory actions if it falls below certain levels and can be reported based on the Authorized Control Level (ACL) or the Company Action Level (CAL) with the ACL calculated as one half of the CAL.??When companies refer to their RBC they generally mean the CAL and formal regulatory actions would not be trigged until it fell below 100%.??

The four action levels include:

·???????CAL:?Insurer is required to submit a plan for corrective action when its TAC is equal to or less than 200% of ACL;

·???????Regulatory Action Level:?Insurer is required to submit a plan for corrective action and is subject to examination, analysis and specific corrective action when its TAC is equal to or less than 150% of ACL;

·???????ACL:?Regulators may place the insurer under regulatory control when its TAC is equal to or less than 100% of ACL; and

·???????Mandatory Control Level:?Regulators are required to place the insurer under regulatory control when its TAC is equal to or less than 70% of ACL.

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