Moody's says outlook for U.S. life insurers stable despite recession, buts sees more consolidation

By Ronda Fears

Nasvhille, Tenn., Jan 3 - The rating outlook for the U.S. life insurance industry will remain stable despite the continuing U.S. recession and the fallout from the Sept. 11 terrorist attacks, Moody's Investors Services said in an industry report Thursday. Analysts at the rating agency believe that industry consolidation will resume in 2002 and beyond as firms seek to strengthen their strategic positions to meet new competitive challenges.

In the report, Moody's said it believes that the industry's many strengths, including sound asset quality, predictable and strong premium flows and low financial and operating leverage will continue to provide support for the industry's ratings. The average insurance financial strength rating in the Moody's universe of 192 U.S. life insurance companies is Aa3/A1.

"The U.S. life industry appears to have emerged from the Sept. 11 catastrophe in relatively sound financial shape. With the exception of a small number of firms that had a high concentration of exposures to Sept. 11, U.S. life insurers' earnings and capital positions will not be materially affected by mortality and morbidity claims related to the Sept. 11 catastrophe," said Patrick Finnegan, a senior vice president with Moody's in New York.

Instead, Finnegan anticipates that consolidation and strategic relationships among companies will remain the industry's principal ratings drivers in the years ahead.

"We expect to see an increase in merger and acquisition activity in 2002, as slower revenue and earnings growth dampens the equity valuations of many small and mid-sized companies, making them more attractive takeover targets," Finnegan said.

Insurers likely to remain independent while keeping their ratings steady are those that successfully balance the interests of shareholders and creditors alike, according to Moody's. Players that report consistent earnings while maintaining healthy risk-adjusted capital levels through periods of market volatility will also retain their high ratings, the report said.

U.S. demographic trends are driving many important changes now affecting the life insurance market, it was noted in the report. Financial planning for the huge cohort of Baby Boomers fast approaching their retirement years, for instance, is prompting insurers to offer a greater variety of products than ever before. This is spurring rapidly growing sales of wealth accumulation products such as variable and equity indexed annuities, as well as wealth transference products. However, Moody's believes that burgeoning sales of wealth accumulation products has also increased insurers' franchise risks. The greater franchise risks are offset somewhat by the fact that insurers' balance sheet risks are better managed than in the past.

"We believe that the surge in wealth accumulation products has increased competition among life insurers and between insurers and other financial services players," said Robert Riegel, Moody's managing director for life and health insurance.

"This heightened competitive pressure will be a major driver of U.S. life insurers' credit quality in the years ahead."

In Moody's view, scale also will play a greater role in U.S. life insurers' operations in the coming years, particularly in the area of product distribution where the competitive battles are being fought most intensely. Captive career sales forces will continue to remain valuable, but will be augmented by other distribution channels such as banks, securities brokers and direct methods like the internet.

"Companies unable to achieve the necessary economies of scale will be gobbled up by larger competitors," says Riegel.

Riegel believes that demutualization and many smaller firms' competitive shortcomings ensure that the trend towards consolidation and convergence will continue in the coming years. Large mutual companies who have recently converted to the stock format will use their improved access to funds to acquire their smaller competitors.

"This will most likely lead to a smaller group of larger, better-capitalized US life insurers in the coming years," Riegel said. "It may also put pressure on the financial strength ratings of some former mutual insurers as they begin to use their excess capital in ways that serve the interest of shareholders versus those of policyholders."

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