A.M. Best Special Report: Blind Curve Ahead--Are U.S. Life Insurers Prepared for What's around the Bend?

OLDWICK, N.J. -- The road ahead looks smooth at first glance for U.S. life insurers, with operating earnings on the rise and strong, stable balance sheets. Equity markets are improving, the credit environment is benign, and interest rates have risen from historical lows. Insurers are renewing their focus on the key discipline of risk management, according to the 2007 Life and Annuity Review/Preview report from A.M. Best Co.

However, A.M. Best believes life insurers are approaching a blind curve where events could adversely impact the industry's financial strength. These include potential effects from a pandemic, another terrorist attack or a significant correction in the equity markets. Also looming over the industry are net outflows for some large variable annuity writers, competition from banks and mutual funds, a prolonged inverted yield curve and a likely downturn in the credit cycle.

The industry's product mix has shifted from protection to asset accumulation and, more important, to more complex products. These are more difficult for consumers to understand; are more difficult for agents and brokers to explain; and bring more policyholder optionality and risk to the insurance company than ever before.

Major players are looking to bolster their competitive positions through pricing, acquisitions and expansion to new markets. This is likely to place pressure on the ability of smaller companies to compete as A.M. Best believes scale and financial flexibility are key drivers of success in the life and retirement savings arena. Meanwhile, ever changing accounting and regulatory rules add complexity and expense.

A.M. Best does not expect these factors to hurt ratings in the near term, but over the long term, the industry will be challenged to keep earnings growing at current rates and to accumulate capital. In turn, A.M. Best expects this to put pressure on ratings.

A.M. Best believes the life insurance industry and the capital markets have become increasingly entwined, a direct result of the industry's heightened risk profile, consumer demand and the economic realities of low interest rates and uncertain credit and equity markets. As a result, the life industry's balance sheet looks much different today than it did just a decade ago.

In today's insurance marketplace, the prudent use of these capital market tools is becoming a core competency for the larger players. A.M. Best believes, however, that the industry needs to continue to focus on the core, fundamental financial and risk-management practices of sound underwriting and pricing, asset and liability management, credit analysis and spread management as the primary tools to build financial strength.

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Founded in 1899, A.M. Best Company is a full-service credit rating organization dedicated to serving the financial services industries, including the banking and insurance sectors. For more information, visit www.ambest.com.