Widening credit spreads and yields from existing bonds are protecting U.S. life insurers' investment returns from the effects of coronavirus-fueled interest rate cuts, but analysts say this cushion will not last forever.

The Federal Reserve on March 16 cut interest rates to between zero percent and 0.25% from between 1% and 1.25% in response to the growing crisis from the new coronavirus pandemic. For insurers, which typically have bond-heavy investment portfolios, a fall in interest rates generally means lower reinvestment rates, because the new bonds they buy to replace maturing ones will pay less interest.

Ten-year U.S. Treasury notes were yielding 0.60% as of early April 2, 2020, down from 1.92% at Dec. 31, 2019.

READ MORE: Sign up for our weekly coronavirus newsletter here, and read our latest coverage on the crisis here.

Offsetting factors

Laura Bazer, senior credit officer at ratings agency Moody's, said in an interview that between 6% and 10% of insurers' bond portfolios are reinvested each year.

Among U.S. life insurers, MetLife Inc. has the largest proportion of bonds maturing in less than a year, at 15.3% of its bond portfolio, according to S&P Global Market Intelligence data. Progressive Corp. is the top of the table in the U.S. property and casualty market, with 22.8% of its bond portfolio coming up for reinvestment in less than a year.

But for now, at least, widening credit spreads are keeping the effect of lower interest rates on reinvestments in check. Although government bond yields are falling, yields are rising for corporate bonds as the outbreak pushes the world toward recession.

Doug Meyer, head of North American life insurance at Fitch Ratings, said in an interview that widening credit spreads had "more than offset" the fall in interest rates.

"So when you're talking about actual reinvestment rates, right at this point in time, it's probably higher," he added.

Insurers' existing bond portfolios are also offering some protection from low interest rates. Speaking on a March 30 webcast about the impact of the coronavirus on insurers, Tracy Dolin-Benguigui, North America insurance sector lead at S&P Global Ratings, said the reinvestment rates on the 10% of U.S. life insurers' portfolio that is renewed annually will be "meaningfully lower," which "could add to the spread compression on life insurers' books," and that as a result "operating performance clearly takes a hit."

But she added that "the industry is managing to offset some of that interest rate pressure" with higher yields from older investments.

Lower for longer

Nevertheless, it will not take long for the lower interest rates to bite. Dolin-Benguigui said that while higher yields on older investments are easing the pressure, "that boost on portfolio earn rate is starting to wither at this point in the cycle."

The benefits of spread widening could also come to an end when the coronavirus crisis has passed since the lower benchmark interest rates are likely to persist. Meyer said that given the response from the U.S. government to the crisis so far, the industry would probably be in an environment where "rates will get lower for longer relative to maybe what we were thinking even at the beginning of this year."

The combination of normalizing credit spreads and lower interest rates will lead to "continued pressure on reinvestment rates and in overall portfolio yields," Meyer added.

In theory, insurers could seek higher yields, for example by investing in riskier or longer-duration assets. But some feel they are not minded to do so, not least because of the other challenges they face as a result of the coronavirus pandemic.

Bazer said: "At the moment they are more focused on liquidity and looking at their life insurance books to see what kind of claims may be coming up, protection of their own employees, business contingency."

Shifting the balance

Instead, insurers are trying to adapt their business to compensate for lower investment returns.

"I think companies are accepting whatever the investment markets give them and recognizing what you have to do on the underwriting side," said Jim Auden, head of North American property and casualty insurance at Fitch Ratings.

For life business, where investment returns need to be closely matched to liabilities, this means repricing business where the contracts allow. Meyer said examples of life business under the most pressure because of the inability to reprice were long-term care and guaranteed universal life.

In general, however, the U.S. life and P&C markets are facing the coronavirus crisis from a position of strength. S&P Global Ratings, for example, has both markets on a stable credit outlook, with 89% of life insurers' ratings and 85% of nonlife insurers' ratings also stable.

Bazer said insurers' risk based capital is "strong" and that companies generally had good levels of liquidity to cover risks, "so they are in a good starting position."

Even so, companies with little business diversification, thinner capitalization and higher-risk asset portfolios could struggle under prolonged tough conditions. Bazer said Moody's base case is for the crisis to last for two quarters, with gradual improvement in the second half of the year.

But if the upheaval lasts, for example, for a year, "there is going to be potential problems among the most exposed companies."