A.M. Best Special Report: U.S. Life/Health Investment Trends--The Search for Yield.

OLDWICK, N.J. -- The overall investment climate for U.S. life/health insurers remains challenging, with a flat to slightly inverted yield curve and tight credit spreads. These challenges have been tempered by relatively benign credit default trends, which are expected to increase to more normalized historical levels, supported by generally higher capitalization levels, according to the recently issued A.M. Best Co. special report on U.S. life/health investment trends. A.M. Best believes that default rates are likely to rise because of the slowing economy; significant amounts of equity capital actively pursuing leveraged buyout transactions and ongoing merger and acquisition activity.

Event risk related to shareholder buyouts poses some risk to the industry, given its high allocation to corporate public bonds that typically lack protective change-in-control provisions and the potential for credit rating downgrades arising from higher leverage. Ongoing spread compression remains a dominant theme as investment managers strive to improve yields while maintaining prudent risk practices on the liability side. Risk management continues to remain a critical discipline as asset managers refine their investment practices in response to increasingly complex equity, spread and policyholder optionality risk embedded in the industry's liability structure.

A.M. Best believes the industry increasingly is becoming exposed to capital markets risk as accumulation products are growing faster than protection products. Growth in the accumulation market segment creates higher exposure to interest rate risk for fixed annuity writers and higher equity market risk for variable annuity writers. Interest rate risk on the liability side remains a primary concern with the potential for disintermediation should interest rates rise.

However, in the near term, the industry consensus is that interest rates actually may decrease in the next year, assuming the Federal Reserve lowers rates to offset the slowing U.S. economy. From a tactical perspective, insurance asset managers continue to place increased emphasis on reinvesting within certain asset classes--specifically, private placements, commercial mortgages, structured products and alternative investments. Additionally, the potential for event risk is being monitored actively by asset managers to identify those bond credits likely to be subject to shareholder actions. Other notable trends include higher portfolio allocations to less traditional asset classes, i.e., credit default swaps, collateralized debt obligations, equity investments, hedge funds and other nontraditional investments.

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A.M. Best Co., established in 1899, is the world's oldest and most authoritative insurance rating and information source. For more information, visit A.M. Best's Web site at www.ambest.com.