(Source: Datamonitor)
In the second half of 2008, US life insurers began reporting large losses, causing non-essential IT projects to be cancelled as budgets were cut. During this downturn in spending, vendors need to align their offerings and message with the needs of their clients, which are increasingly focusing on reducing costs, and improving risk management and compliance abilities.
The life insurance industry in the US is facing a challenging period. In the second half of 2008, life insurers began reporting large losses caused by write downs of assets and deferred acquisition cost (DAC) unlocking charges. The losses continued through the first quarter of 2009 and may continue for a few more reporting periods, although the current rally in equities is a great relief. Additionally, the industry is facing a cyclical downturn, as cash-strapped consumers forgo or scale back on everything from basic term coverage to retirement planning. To make matters worse, the Obama administration recently proposed a tax hike that could result in $12 billion of new expenses for the industry and its consumers.
To date, the biggest issue facing the industry has been fledgling investments. Everything from plain-vanilla equities to mortgage backed securities, corporate debt and alternative vehicles has fallen in value. As such assets deteriorate or become worthless, as is the case with Lehman Brothers' bonds and certain tranches of mortgage backed securities, insurers have taken losses on their portfolios. Additionally, bond defaults and dividend cuts have reduced the amount of cash generated by portfolios. Lastly, insurers have been unable to find yields among government debt, because a rush to safety has pushed up the price of government paper, thus lowering yields. Although yields on government debt are returning, they are doing so for the wrong reason: soaring government deficits and the threat of ratings downgrades have elevated risk premiums.
Insurers selling variable annuities have been particularly hard hit. During the good times, insurers sold variable annuities with generous guaranteed minimum benefit riders. At the time of sale, insurers book the cost of acquisition to the asset side of the balance sheet and then expense the costs over the life of the policy. These assets, called DACs, are based on a number of assumptions, including equity market returns and fixed income yields. As the markets went south, insurers have had to readjust these assets downward in what is called DAC unlocking.
In light of the dire conditions, the major rating agencies have downgraded a number of life insurers, thus raising the cost of capital and making it more difficult to rebound.
