Solid economic growth, strong investment returns, and manageable COVID-19 mortality claims made 2021 a strong year for life insurers. As we start 2022, the picture is a bit clearer than it was one year ago; the continuing pandemic still creates a meaningful amount of uncertainty, albeit less than in the past. The overall positive trajectory the industry was on last year may continue, but most likely in a more subdued format, with lower sales growth, stable capital levels, and reduced earnings compared to last year.

S&P Global Ratings still sees potential risks to life insurers' investment portfolios, headwinds from elevated mortality claims, and earnings pressure from seemingly everlasting low interest rates. But the life industry is well positioned to deal with those due to strong capital buffers, ample liquidity, and robust risk management. So once again, our outlook on the U.S. life insurance sector is stable, as we believe most of our ratings in the sector are unlikely to move up or down in the coming year.

Sales Will Likely Remain Strong But Won't See The Same Level Of Growth As 2021

Life and annuity sales growth was especially strong through the first nine months of 2021. Part of the growth was due to the relatively low sales in 2020, but many product categories saw impressive growth last year, even when compared to 2019 sales. Individual life sales, for instance, grew 18% in the first three quarters of 2021 compared to the corresponding time frame in 2020; this compares to year-over-year growth rates of 0%-6% in the previous decade. Although it's difficult to pinpoint the exact drivers of 2021's sales increases, they were likely heavily influenced by pandemic-related issues such as pent-up demand from 2020 and mortality being top of mind for many people. These drivers are likely to moderate or dissipate going forward, so we believe it is likely this year will see less dramatic sales growth.

The life industry had to adapt to a new reality as the pandemic restricted face-to-face meetings and travel. This environment forced the distribution side of the industry to embrace remote technology, and to accelerate the digitization that was already underway. While not without its challenges, this process seems to have increased efficiency in at least some parts of the distribution ecosystem. Wholesalers no longer need to travel to meet agents in the field, some agents can reach more clients and prospects in a day with remote video tools than they did before, and underwriting can be done much faster and usually more cheaply. These efficiencies are likely here to stay, but it remains to be seen whether they will enable to industry grow sales faster or reduce acquisition costs.

If inflation remains high in 2022 and interest rates rise, sales may be impacted going forward. On one hand, higher yields on fixed income investments may allow insurers to offer better crediting rates on spread-based products like fixed annuities and universal life, making them more appealing to potential customers. On the other hand, rising prices may squeeze marginal consumers, forcing them to deprioritize life and annuity products.

Life insurance products

As noted above, individual life insurance sales grew by an unprecedented 18% in the first three quarters of 2021 compared to the same period in 2020. Variable universal life was the clear growth leader, with 78% growth over 2020, but it remained relatively small in terms of market share (11%). Other life insurance products also grew impressively above historical rates. Over the past few decades, individual life insurance in the U.S. has grown at a pace that more or less tracked GDP growth. We do expect modest increases in whole life and indexed universal life sales as companies move past regulatory and tax code related product and pricing changes. Term life sales will continue to benefit from improved digital sales capabilities that have gathered momentum during the pandemic. That said, it seems unlikely that 2021's high growth rates are sustainable for the long term, short of a remarkable increase in insurance market penetration or a paradigm shift among consumers--neither of which seems likely.

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Group life also rebounded in 2021, with growth in premiums, number of employees covered, and number of employer groups, after these saw significant declines in 2020. Group life and employee benefit sales are typically impacted by unemployment and workforce participation rates, and as the rapid economic growth of 2021 subsides in 2022 and beyond, we expect sales growth in the group market to ease as well. Moreover, as group life contracts approach their renewal cycle, we expect sales to reflect the impact of pricing actions that we believe companies may take to incorporate the elevated mortality witnessed in the second half of 2021.

Annuities

Annuity sales also made a strong comeback in 2021 after a tough 2020, when almost all product sales declined. Total annuity sales grew by 19% in the first nine months of 2021 compared to the same period in 2020, with all product types showing double digit increases, save for single premium immediate annuities, which showed a modest decline. It may be the case that when full-year data is available, 2021 will show the highest growth and highest total sales in the last decade. That impressive growth notwithstanding, it may not be an indication of a trend but rather a return to typical sales levels after a low point in 2020. Annuity sales in the U.S. have fluctuated around $230 billion per year for the last decade, with one annuity product's sales growth coming at the expense of another's contraction. This stagnation in sales is counterintuitive to the fact that the potential buying pool of retirees is growing rapidly (the AARP estimates that over 10,000 Americans turn 65 every day). Low interest rates are likely a large driver of this phenomenon, as well as insufficient savings for retirement among large parts of the U.S. population. There seems to be no reason to believe 2022 and beyond will see consistent growth in total annuity sales.

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Registered index-linked annuities (RILAs) had very strong sales in the first nine months of 2021, outpacing full-year 2020 sales by 18% and full-year 2019 sales by 63%. This notable increase is most likely an outcome of insurers and distributors shifting sales resources toward this product over the past two years. RILAs, like most life and annuity products, are sometimes referred to as "sold products, rather than bought," as very few consumers independently seek them out; nearly all sales happen after an agent has reached out to a potential prospect. As such, insurers and distributors have considerable influence on the makeup of annuity sales, and as more companies have been prioritizing RILA sales over other products recently--particularly traditional variable annuity with living benefits (VA)--RILA sales have increased. We believe this trend will continue and that more insurers are likely to enter the RILA market in 2022 and 2023, leading to more sales-- likely at the expense of VAs and fixed index annuities (FIAs)--and more competition.

While sales of traditional VAs have been declining fairly consistently since 2011, the first three quarters of 2021 saw a 17% increase in sales against the corresponding period in 2020, and a modest 4% increase over the same period in 2019. It's too soon to tell whether this represents a turning point for traditional VAs, but there are reasons to think that it does not. Two top tier insurers, Prudential and Transamerica, which collectively accounted for 8.5% of 2020 traditional VA sales, exited the market in 2021, and there are similar trends among third-party distribution. With no new entrants into the traditional VA market, existing players may not be interested in or may not have the capacity to expand their own sales to make up for those from the exiting companies.

Both FIAs and fixed-rate deferred annuities, which together make up the bulk of fixed annuity sales, grew in 2021 but also seem to have lost market share to RILAs. In recent years, more insurers that are owned by, or otherwise associated with, private equity (PE) firms have become more active in the fixed annuity market. This has brought more capital, more competition, and sales growth to the space, particularly in FIAs. This growth has come at the expense of traditional VAs and fixed-rate annuities, and the increased competition has also driven a few large insurers to leave or pull back from the fixed annuity space. Fixed annuities are a spread business, and PE-affiliated insurers have been successfully competing in this market by typically investing more aggressively than traditional life insurers (see more on this in the investments and capital sections below). If the sales growth in RILAs continues and comes at the expense of FIAs, causing the run that FIA sales have had in the last few years to slow or plateau, it might impact the competitive dynamics in this space over the next few years.

Institutional markets

After a halt in activity during most of 2020, the pension risk transfer (PRT) market came roaring back in the fourth quarter of 2020 and in 2021. PRT sales tend to be seasonal, with fourth-quarter sales usually greatly overshadowing the rest of the year. While we still don't have full data for 2021, third-quarter sales of PRTs were nearly $16 billion--higher than any quarter on record, including previous years' high-watermark fourth quarters. We believe this trend, helped by slightly higher nominal interest rates, improved funded status of pension plans, and corporate America's need to offload its defined benefit obligations, will likely keep sales growth positive over the next couple years.

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Over the last few years, the funding-agreement backed note (FABN) market has grown significantly, both in size and in the number of insurers that issue FABNs. In the first nine months of 2021, the average outstanding amount of FABNs hit $131 billion, matching the on-record peak of 2008. If managed well, FABNs can be a profitable and stable source of earnings for insurers--for the duration of the liability (typically three to seven years). Demand from institutional buyers seems strong for now, but the FABN market has seen large and swift contractions in the past, so we view it as an opportunistic source of profit for the industry rather than a staple.

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Robust Capital Levels Are Likely To Carry Into 2022

Capital adequacy is a crucial metric for life insurance companies, and it remains a key strength to the sector (see chart below). On the capital growth side, during the first three quarters of last year, insurers had a banner year of high earnings, fueled by high returns on alternative investments and the strong growth in the economy and the equity market. Anecdotal information suggests fourth-quarter 2021 earnings will also be strong. Capital markets remain open and life insurers issued a fair amount of debt and hybrid securities, albeit at lower levels than in 2020. On the flip side, players in the life industry also deployed significant amounts of capital via organic sales, as mentioned above, and through record mergers and acquisitions (M&A) activity. Share buybacks and dividend increases also reappeared after a brief hiatus in 2020 and we expect this trend to continue.

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At this time, we still don't have data for full-year 2021, so we can't definitively tell whether these different forces pulling at companies' capitalization have significantly shifted the robust capital position that the market had coming into 2021. Early indications from third-quarter 2021 results suggest that capitalization levels at most life insurers will not dramatically change in either direction, and that the industry enters 2022 with robust capital levels, but results will naturally vary from company to company.

Our base economic forecast expects an easing of GDP growth in 2022; in addition, the impacts of the omicron variant may potentially slow the economy further, though perhaps not as dramatically as previous waves. Thus far, the omicron wave has not greatly increased COVID-19 related deaths in the U.S., but it does remind us that the pandemic is not over and that life insurers are still exposed to elevated mortality claims. So far in the pandemic, excess mortality from COVID-19 has had a manageable effect on life insurers' earnings and capital and we expect this trend will continue.

Slower economic growth, normalized returns on alternative investments, and slightly elevated mortality may all serve to temper life insurers' operating performance in 2022, compared to 2021.

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Most life insurers pay very close attention to their capitalization and try to carefully balance sources of capital (e.g., earnings, issuance, M&A) and uses of it (e.g., new sales, M&A, return to shareholders) to maintain their desired levels of capital and leverage. We expect insurers will continue to be prudent in their capital management and will likely maintain the robust capital positions they hold today.

The M&A Train Will Keep Rolling In 2022

M&A in the U.S life insurance sector continued its very active multi-year trend. Most transactions in the last few years directly involved a PE firm or a life insurer that is owned or otherwise affiliated with a PE company. While there were transactions that did not involve PE, a few distinct themes have emerged among PE-related deals.

One popular theme of recent M&A deals is the increasing involvement of PE firms in the fixed annuity space, both through the acquisition of run-off blocks of older business and through varying ownership stakes in insurers that compete in the new issuance market. Other PE-affiliated insurers have been buying large run-off blocks of traditional VAs, although a few companies play in both the VA and the fixed annuity markets.

There were deals that reflected the trend of continued consolidation in the retirement services sector, and other transactions that can be filed under the "death of the multiline insurer" headline, in which insurers that had both life and property/casualty subsidiaries divested their life businesses.

Because we see little evidence to suggest that any of the forces driving the life insurance M&A market are abating, save perhaps for the fact that there are not many multiline insurers left, we believe the activity will likely continue in 2022 and 2023.

Table 1

Most transactions in 2020 and 2021 were neutral to ratings, and a minority were potentially negative, typically engendering a negative outlook or CreditWatch rather than an immediate downgrade. It remains to be seen whether future deals will have similar results. We will continue to assess each deal on a case-by-case basis, analyzing risk tolerance, pricing discipline, business concentrations, leverage, capital and earnings impact, and other factors to determine the rating impact, if any.

Investment Risk Has Been Kept At Bay, But Leverage In Corporate Credit Is High

One of the unique aspects of the economic crisis brought about by the COVID-19 pandemic in 2020 was the quick intervention by central banks across the world that muted what could have otherwise been a much bigger wave of downgrades and defaults in corporate credit and real estate markets. This ended up being good for life insurers, as corporate bonds, loans, and real estate, in one way or another, make up the bulk of assets in their investment portfolios. The industry's capital buffers absorbed the limited impacts of 2020 and positioned investment portfolios well to enter 2021--a year in which corporate bond downgrades were few, credit impairments were minimal, and alternative investments delivered outsize results.

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We think the robust returns on alternative investments seen in 2021 are not sustainable, although it's impossible to pinpoint when a mean reversion or market correction will happen. Market disruptions from future waves of COVID-19 are less likely than they were at the beginning of the pandemic but remain a downside risk to investment portfolios. One of the unintended consequences of the swift government actions during the pandemic is that leverage in the corporate sector remains higher than pre-pandemic levels, making any future crisis possibly more severe if it happens before the corporate sector can successfully lower leverage. While impairments on bonds remained low in 2021, it is possible we will see higher levels of write-downs on corporate credit securities and real estate-related investments in 2022 despite the continued economic recovery.

None of us know when the next crash is going to occur, and what kind of action the Federal Reserve and its counterparts around the world would be willing or able to take. Excessive risk taking in the investment portfolio while relying on future government intervention is unwise, to say the least, but we do not believe this is a common practice in the U.S. life industry.

To be clear, investment in higher risk assets does not necessarily mean an insurer is taking on too much risk. As long as the company holds sufficient capital against the higher asset risk and has robust risk management practices to monitor and govern its investments, we believe its credit profile and rating can be stable. In our analysis, we believe those life insurers who invest more aggressively (a group that includes mostly PE-affiliated insurers, but also a few that are not), currently have the capitalization and the risk management chops to support their existing ratings. We remain vigilant and continue to monitor life insurers' investment portfolios for any material investments or changes in investment policy that we think may impact their ratings.

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Beyond 2022

LDTI is around the corner

The Jan. 1, 2023, deadline for publicly traded companies to implement the generally accepted accounting principles (GAAP) accounting long-duration targeted improvements (LDTI) is fast approaching, and it seems unlikely to be pushed out further. Some life insurers have already begun to disclose the upcoming impacts of LDTI on their balance sheets, and we expect most GAAP filers to follow suit this year as we get closer to the implementation deadline.

We believe that a change in accounting standards, by itself, will not have any material impact on life insurers' creditworthiness--a company that is well capitalized on the evening of Dec. 31, 2022, will remain so on the morning of Jan. 1, 2023. Having said that, we will closely examine any disclosures that companies provide and work with them to understand whether they bring to light any material issues our analysis has not captured to date, although we do not expect this to be the case. It is also worthwhile to note that LDTI will only change GAAP financials; statutory accounting--which we use for most of our capital analysis of U.S. life insurers and which governs cash flow out of regulated insurance companies--is not changing.

Market reactions to large changes in GAAP equity or GAAP earnings brought on by LDTI, or management teams' perception of such market reactions, may drive M&A and other strategic decisions in the life industry this year. As we always do, we will analyze these as they come on a case-by-case basis to determine the rating impacts, if any (see "Credit FAQ: GAAP Accounting Standard Changes Could Propel Long-Term Shifts In Life Insurers' Strategies," published Oct. 28, 2019).

Low interest rates will continue to pressure life earnings for the foreseeable future

At this point, low interest rates are not news to anyone in the life insurance industry, and companies have been managing through them for over a decade. Even with the prospect of higher inflation, at least for a period of time, and the expected rate hikes by the Fed this year and next, we think low interest rates on the longer end of the yield curve will continue to weigh on earnings in 2022 and beyond.

Impacts will naturally vary by issuer, product suite, capital position, and overall net earnings spread. Companies that hold annuities with guarantees would be the most sensitive to low interest rates. Nevertheless, we think life insurance companies will be able to withstand such headwinds in the coming few years. We looked at the difference between tabular interest rates on annuity reserves as a proxy for the crediting rates and compared it with investment yields, 10-year Treasury rates, and 'A' rating level credit spreads (see chart below). Companies are still earning an investment spread over their minimum guarantees, though that is declining. For more details, see "How Prolonged Low Interest Rates Could Affect U.S. Life Insurers," published June 9, 2021.

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Technology and digitization continue to advance, but costs might be a concern

The pandemic greatly accelerated the adoption of technology and digitization processes across the entire value chain of life insurance, from product design, through underwriting and even sales calls done via video conferencing. The life industry, which was lagging other financial services sectors in terms of adoption of technology, is quickly catching up but still has a ways to go.

Thus far, expenditure on technology has not negatively impacted the industry's profitability in a material way, primarily since a typical life insurer needs to interact with thousands of agents rather than millions of end consumers, so the costs are limited. It remains to be seen whether these costs will grow as insurers continue to invest in technology and continue to compete to acquire insurtech start-ups.

What Could Weaken The Industry Outlook?

The following are potential downside scenarios.

Capital drain.  Capitalization levels decline because insurers significantly reduce their strong capital buffers either via an unexpected increase in shareholder returns or from unexpected organic or inorganic expansionary moves.

Race to the bottom.   However unlikely, insurers increase their risk tolerances via increased product or pricing or asset risk, such as greater use of richer guarantees or aggressive underwriting assumptions related to rates or lapsation, or a deterioration of investment portfolios.

Market displacement.   Dislocation in the capital markets from higher-than-expected corporate bond defaults results in more credit losses and worsening capital levels. Also, a significant spike in rates--such as 300 basis points over a short period of time--could increase disintermediation risk. Additionally, a severe drop in the equity markets could hurt insurers with meaningful market-exposed guarantees.

Rating And Outlook Distributions

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