< PreviousAuditors & Actuaries 28BEST’S REVIEW • DECEMBER 2022 on your mix of business, you could have some negative impacts in certain blocks and then in others you could have significant positive impacts if policyholders stay. There are many people who think if inflation continues to be high, the Fed will continue to increase interest rates. And so that’s another question. We’ve been on a 30-year, at least, downward trend of interest rates. And it sort of bottomed with COVID when you had a 50 basis point 10-year Treasury. Ever since then, it had been coming up. And then in 2022 after March it really rapidly went up. There have been some times in the last 30 years where interest rates did go up 2% or more in a year. But those periods generally were followed by further decreases and rates continued to be low. Therefore, there’s this possible short-term benefit of interest rates going up. But do you think it’s going to be sustained or is it temporary? And so, as an example, if we go into recession and maybe inflation gets tamped down, then you would expect the Fed to start going in the other direction because unemployment’s going up and maybe they did too much in increasing interest rates too high. That goes back to my volatility question. It’s hard to know where interest rates may go based on all these other factors, inflation being one of them. There’s just many drivers of the significant increase in inflation and which ones will be stopped and or be fixed? You can think of the war on Ukraine. That’s at least part of the driver of increased energy prices and inflation. What if the war all of a sudden ends? Does that then ease some of the pressure on inflation? But you’ve still got supply chain issues. In the U.S. and many countries, you had all of this pent-up consumption demand from people who were locked up in COVID that has been released. That doesn’t necessarily go away in the short term either. So a lot of the question on inflation is, is it temporary? When will it slow down? Does that then ease the pressure on interest rates? Does that then mean interest rates are going to come back down at some point? There’s just a lot of uncertainty right now. The other comment I’ll make is a lot of insurance companies over the last few years, as interest rates have been low, have been lengthening the duration of their bonds to protect against further declines in interest rates. And some have also been going riskier to compensate for investment yields that have been coming down. Those things now are putting companies, at least relative to before, in a worse position to benefit from the rise in interest rates. If you had bought longer bonds, interest rates going up means the losses on those bonds will have been bigger and you don’t have as much money rolling over to take advantage of these higher interest rates. If you’ve gone riskier—we’ve seen the stock market went down a lot. But there’s also been spread widening on some of the riskier bonds, too. So once again, if you’ve gone riskier, you’re potentially seeing more of these riskier assets with greater potential losses if you have to sell them. So some of the actions that companies have taken to try to compensate for the lower interest rate environment could mean that, in some instances, they may take more losses and may not be able to benefit as much from the rise in interest rates. “Part of the roundtable message was volatility is likely going to continue. And from an interest rate perspective, generally people assume: ‘Interest rates are up? You guys have been complaining for such a long time that they’ve been low. Aren’t you just super happy?’ The answer to that question depends on the blocks of business that you have.” Nik Godon WTWCommitment Beyond Numbers Beyond Transactions pinnacleactuaries.com ReinsurancePricing and Product Management Predictive Analytics Loss Reserving Litigation Support Legislative Costing Enterprise Risk Management Alternative Markets It’s about partnerships and relationships. When you work with Pinnacle, you become a partner. We start by getting to know your organization’s business goals, geographic and industry mixes, risks and corporate culture. Our consultants provide you with the highest level of professional expertise and service. The result is a true partnership to help guide you through available options and make better business decisions.Auditors & Actuaries 30BEST’S REVIEW • DECEMBER 2022 What about climate change? Climate risk is a core issue for property and casualty companies. They have to worry about storms, fires, floods and the property damage that comes from these natural disasters. From a life insurance perspective, it’s less immediately obvious how climate risk impacts life insurance actuaries on this topic. For starters, there are more demands now coming on insurance companies on the investment side in particular. What are you investing in? What is your climate footprint? Are you investing in companies that are potential contributors to an increase in climate risk? There’s pressure on companies in terms of disclosing what are you investing in and what’s the climate impact of those investments. You’ve also got more risk in some cases depending on where your assets are. Do you have a lot of real estate investment in Florida as an example? And so you have to think about what do I want to invest in? What are the risks on some of these assets? On the life insurance risk side, another question is what will climate risk, global warming, do from a mortality perspective? You would think if climate risk continues to get worse that possibly there might be some longer- term impacts from both a health perspective as well as a mortality perspective. You certainly can see when there’s large heat waves, there typically are excess deaths that happen in the elderly population. Drought and lack of water is another effect of climate change. There are many places right now that are starting to run out of water. What does that mean from a health detriment perspective? How do people handle that? So on the life insurance risk side, it is not fully clear yet how climate is going to impact mortality. Thus, there is more short-term focus on what’s the impact on the asset and investment side of things. Should actuaries be concerned about the climate risk issue? Climate is a new developing topic that actuaries should become or at least start to be aware of because their companies are going to have to start disclosing more information on it. Actuaries also want to try to be in on developing a better understanding and assessment of the impact of climate risk, including what scenarios should we look at as an insurance company. Actuaries are wanting to be part of the solution rather than just reacting to it. There’s new courses and training being developed from an actuarial perspective to provide some more insight and background for those who are interested in those topics, such as the climate risk certificate under development by the SOA. Because we do think this topic is going to be growing in importance. Are there any other issues or topics that are on the minds of actuaries as we head into 2023? There’s a lot of change going on because of financial reporting changes for public insurance companies that start on Jan. 1, 2023. You’ve got the U.S. GAAP changes known as LDTI—Long Duration Targeted Improvements. If you are an international company, you’ve got IFRS 17. Some companies have a few more years to deal with the U.S. GAAP changes. If they’re privately held, they have at least two more years until 2025. There’s a significant amount of effort in the entire industry, not just for actuaries but for accountants, too, to get ready for reporting on what, in some cases, are very significant changes in how insurance business is reported. There are questions on whether these reporting changes will drive longer-term changes in what products are offered and how we view profitability. That’s certainly an ongoing big topic that will continue to be a challenge for people well into 2023 and possibly beyond. So that still is a very hot topic. M&A is certainly something still having a significant impact on the industry. Companies are evaluating whether or not they want to divest of annuity blocks or UL blocks. So that continues to be a hot topic. Finally, topics around innovation and modernization continue to be at the forefront of industry discussions. The greater use of data in underwriting and ethical considerations surrounding that continue to be an important topic that is growing in importance from an actuarial perspective. BRMove forward with Mazars Our dedicated insurance leaders have decades of experience in the sector, serving US and international groups. We’re committed to understanding your organization’s goals and assisting you in achieving them. Experience a different perspective www.mazars.us32BEST’S REVIEW • DECEMBER 2022 MassMutual Prepares for the Worst Amid 2023 Warning Signs As 2022 draws to a close, Chairman and CEO Roger Crandall seeks to build on the company’s strengths in technology and annuities as any number of issues— inflation, interest rates, the Russian invasion of Ukraine and energy volatility— weigh on his mind. by Terrence Dopp W ith even the Federal Reserve warning a recession could be in the cards for 2023, Massachusetts Mutual Life Insurance Co. Chairman and Chief Executive Roger Crandall hopes to gird against any potential rough patches by going more digital. By bolstering its migration to a new, more efficient platform, Crandall said the digital investment will allow MassMutual to better attract customers in a tightened sales environment and will make their products more attractive to distributors. He said the effort will streamline its operational costs Life Insurance Photo courtesy of MassMutual Terrence Dopp is a senior associate editor. He can be reached at terry.dopp@ambest.com. Key Points Tech Focus: MassMutual plans to continue to invest in its technology platforms. Life Products: The company plans to be flexible to respond to the changing interest rate environment and consumer demand. Looking Ahead: Inflation, rising interest rates, recession and geopolitical risks are concerns for 2023.33BEST’S REVIEW • DECEMBER 2022 while improving both the internal and external experience. At the same time, he said the company is focused on preparing its balance sheet and product mix as needed to avoid trouble. “This is the most anticipated downturn in a long time,” Crandall said. “But it’s hardly the first rodeo for MassMutual seeing downturns. So we want to make sure we get a breadth of product, a breadth of distribution, and then the balance sheet to make sure that we’re going to be able to provide what our policyholders always look for from us.” The digital investments continue the company’s efforts to build on its technology since it founded Haven Life in 2015, when it hoped to capture a younger audience through an all- digital product. The new outfit, which was designed to operate as a startup at heart within the older company, has operated as an independent subsidiary while enjoying the backing of MassMutual. Crandall said nearly 60% of MassMutual policies are written using its less costly and quicker platform. Early this year, the company spun off Haven Technologies. That venture is based on the premise that the largest issue confronting the life insurance industry is a technology gap in the computer systems that take a customer from the initial quote through claims management. As a result, Haven Technologies sells a digital platform to carriers. The aim is to create a new area of revenue growth outside of pure life and annuities, he said. “We need to use technology to reach everybody,” Crandall said. “And that’s where the investments we’ve made, again, personified really in the spin out of Haven Technologies, I think sets us up for some continued growth ahead right now.” Outside Forces As 2022 closes, the potential for a looming recession, a major land war in Europe and rising interest rates that have pushed down other areas of investments have conspired to create an uncertain road ahead. “The Fed is raising rates aggressively, the economy is seeming strong, but everyone’s feeling really nervous in part because inflation is the highest it’s been since my dad worked at MassMutual,” said Crandall, whose father was a salesman there for 30 years. “It’s been kind of quite a year, but from a MassMutual perspective, it’s also been really a phenomenal year.” One of the biggest questions in life insurance at the moment is how rising interest rates and a potential recession may impact the roster of products carriers offer and which ones are competitive. Just as a decade of economic growth in a low-rate environment forced companies to shift their offerings, the road ahead could be just as impactful. MassMutual also needs to concentrate on the products it offers and find ways to remain flexible in responding to market forces, Crandall said. Ordinary life insurance was MassMutual’s largest insurance line at 30.7%, and individual and group annuities were 33.5% and 33.4%, respectively, according to AM Best. The company is the eighth largest U.S. life/health carrier with $100 billion of total life insurance policies issued. With its $3.5 billion acquisition of American Financial Group Inc. subsidiaries in 2021, MassMutual gained access to the Great American Life Insurance Co. —rebranded as MassMutual Ascend —and its two insurance brands, Annuity Investors Life Insurance Co. and Manhattan National Life Insurance Co. MassMutual Ascend and its subsidiaries had about $40 billion of traditional fixed and indexed annuity reserves at the close of 2020, the company said. While the 2022 annual report hasn’t been released yet, Crandall said annuity sales are up almost 100% this year following a strong decade and sales of life insurance products grew by nearly 14% year-over-year. Even so, should the short- and long-term yield curve invert and remain so for a “This is the most anticipated downturn in a long time. But it’s hardly the first rodeo for MassMutual seeing downturns. So we want to make sure we get a breadth of product, a breadth of distribution, and then the balance sheet to make sure that we’re going to be able to provide what our policyholders always look for from us.” Roger Crandall Massachusetts Mutual Life Insurance Co.Life Insurance 34BEST’S REVIEW • DECEMBER 2022 while, the company is ready to shift greater emphasis to its smaller universal life segment in response. The company is also prepared to shift toward income and fixed annuities if they become what is most attractive to the market. And, of course, maintaining both a broad distribution system and capitalization will be important, he said. “Making sure that our advisers have the right products to sell and then continuing to invest in technology for our agents is important,” Crandall said. “We want to be ready for whatever the market brings us there.” As far as its own balance sheet, MassMutual is focusing on bolstering its capital position to ensure if there is a recession the company can carry through. While there’s been unease for life insurers looking at the current economic climate and unrealized investment losses, there still haven’t yet been any wholesale problems for the industry. How that situation develops will be a determining factor in the coming 12 months, Crandall said. “So talk about the year ending differently than it started, right?” Crandall said. “The question is, are we going to have a credit cycle? Remember, we actually haven’t had much in the way of credit losses. We haven’t had a lot of impairments. “The industry is in good shape and MassMutual is in good shape. We have over $33 billion of total adjusted capital, the highest level we’ve ever had, strong RBC, strong asset quality,” Crandall said. The various underwriting entities of MassMutual have Best’s Financial Strength Ratings ranging from B++ (Good) to A++ (Superior). The company was rated by AM Best as having the balance sheet strength assessed as the strongest in a July credit report with a diversified investment portfolio, risk-adjusted capitalization and strong liquidity. The Road Ahead It’s no surprise that Crandall’s thoughts would turn to the year ahead as this one comes to a close. He cites geopolitical risk—he called Russia’s invasion “horrific”—as a top-level issue, along with inflation and volatility of energy prices and world currencies that can spill over. Another area that keeps him worried is a cyberattack, possibly from Russia as part of the war, and the need for insurers and the broader economy to be prepared for it. The dual challenges of inflation and recession are also major concerns. The Fed raised rates six times during 2022, including multiple 0.75 percentage point increases starting in July as the fight against inflation took priority and other indicators warned of recession. The Fed said it will monitor economic indicators such as inflation, labor markets and public health in assessing any future rounds of increases. That marks a sharp departure from the lengthy low interest rate environment of recent years. Interest rates dipped amid the 2008 financial crisis and remained at low levels for over a decade. They again flirted with zero in the first half of 2020 as the COVID-19 pandemic closed down economies. The balancing act the Fed must pull off is ensuring the increases are steep enough to curb inflation near four-decade highs but not at such a rate that it plunges the U.S. economy into a deep recession. After a September rate increase, the Fed’s Federal Open Market Committee predicted a rise in unemployment to 4.4% in the coming year along with gross domestic product growth of 1.2%. “I think one of the great questions going into 2023 is, is the Fed going to overshoot here and drive us into a recession in the attempt to get inflation under control?” he said. “The simple answer is, we don’t know. We want to be prepared in case that happens, as we always are.” The rising rates have prompted volatility in equities markets. Crandall said as a mutual life insurer his company’s exposure to publicly traded stocks is small. Given the rate of Fed rate hikes, he said MassMutual will need to monitor in near-real time its pricing structure. “It’s not unusual now to have moves in a day that you might have seen in a month all that long ago. You need to make sure you’re very kind of quick on your pricing there,” he said. “On the product side, that’s really where we’ve been focused.” At the same time that it readies for 2023, MassMutual still needs to keep an eye on long-term operations. Crandall said it intends to continue to focus on technology improvements, responding to the needs of a post-pandemic workforce and growing its presence in the sought-after middle market. “You really don’t want to see high unemployment and consumers having trouble paying their bills and paying their car loans and their mortgages and rents, etc.,” he said. “I think the concern about the economy really tipping into a real recession will be the other part of my trifecta of things to worry about today.” BR35BEST’S REVIEW • DECEMBER 2022 Asset Management Insurers’ Balance Sheets Increasingly See Unrealized Losses in Rising Asset Management Challenge A new consequence of rising interest rates rears its head as unrealized losses crop up. For insurance asset managers, one option might lie in taking paper losses after a decade of low rates crimped investments. by Terrence Dopp I nsurers are seeing unrealized losses in their long-dated bond portfolios swell as the Federal Reserve raises interest rates, adding pressure at a time when stocks are down and recessionary fears are in the air. With all indications signaling the Federal Terrence Dopp is a senior associate editor. He can be reached at terry.dopp@ambest.com. Key Points Rising: The Fed has raised rates six times in 2022, most recently in early November, and doesn’t appear ready to reverse course anytime soon. Impact: As new publicly traded debt carries a higher interest payment, the corollary is that debt that was previously issued becomes less attractive and falls in resale value. High: In fact, AM Best estimates the value of all unrealized losses across the industry was even greater than those seen at the beginning of the COVID-19 pandemic.Asset Management 36BEST’S REVIEW • DECEMBER 2022 Reserve is unlikely to reverse the increases anytime soon, the issue could become one of the defining factors of asset management for insurers going forward. After a decade of studiously plotting new places to park cash, they are finding the gulf widening between what’s on the books now and new business. Patryk Carwinski, a portfolio manager with Asset Allocation and Management LLC in Chicago, said the heavy reliance on investment-grade bonds on the part of the insurance industry has resulted in unrealized losses regardless of whether they held long- or shorter-duration debt. Life carriers, which tend to congregate at the longer end of the maturities scale, have been hit the hardest, he said. AAM had $25.7 billion in assets under management for 121 insurance company clients as of Sept. 30. “These unrealized loss positions in their portfolios will continue to persist for some time,” Carwinski said. “They don’t have to realize those losses. It does prevent them from being a little more active in the portfolio than we would normally be. Portfolios are underwater, and as a manager, I can’t make certain trades without considering the profit and loss impact for a company.” The rationale is simple. Those bonds continue paying the same amount. At the same time, as rates rise, every newly issued debt instrument pays a higher coupon. As investors gravitate toward the higher interest rates, the resale value of existing bonds issued at the lower rates craters because they have a smaller return. The public debt market offers insurers known returns without the wider swings equities markets can make. Yet after years of low rates and easy money nibbled away at the returns found on that “That’s going to come through over five or seven or eight years, but the mark-to-market is now. So you have a large short-term detriment and a long-term tailwind.” Erik Miller AM Best -120 -100 -80 -60 -40 -20 0 20 40 60 80 ($ billions) US GAAP – Unrealized Gain/Loss on Fixed Maturities by Quarter, 1Q20-2Q22 1Q203Q204Q201Q212Q213Q214Q211Q222Q222Q20 Source: 37BEST’S REVIEW • DECEMBER 2022 market, 2022 saw volatility in bond pricing as participants waited to see see just how far rates can rise in an effort to avoid betting on bonds that lose value with subsequent rate hikes. Rising Losses According to an October AM Best Special Report: Rising Interest Rates Leading to Large Losses on Fixed Maturities, unrealized losses on investment portfolios through the second quarter had exceeded those suffered in the first quarter of 2020, at the start of the pandemic and the economy-sputtering lockdowns. In a November AM Best Commentary: Impact of Rising Interest Rates on Insurers’ Balance Sheets Will Depend on Accounting Method Used, AM Best found the impact depended on accounting methods. “Insurers using a market value approach saw available capital decline significantly; those using an amortized cost approach reported no effect on available capital,” the report said. Erik Miller, associate director at AM Best, said the mark-to-market declines are sure to be seen across the industry as newer bonds gain in attractiveness. However, he said the concern is less in that area and more concentrated on the liquidity issue and the need to increase surpluses. For instance, he said a company that bought a public 30-year bond, the value could be down as much as 30% to 40% in the current market. The longer the maturity, the greater the impact will be. “Think about companies with an average duration of five or seven or eight years,” Miller said. “That’s going to come through over five or seven or eight years, but the mark-to-market is now. So you have a large short-term detriment and a long-term tailwind.” The trend could be clearly seen in companies’ second- and third-quarter earnings reports across the larger insurance industry and in many lines of coverage. While rising rates are a good thing in the long run as investment assumptions rise, the shorter-term squeeze can’t be ignored, he said. On the Books Cincinnati Financial Corp. in late October reported a $418 million net loss for the period, primarily due to a $557 million decline in investments. For the quarter, the company reported a $514 million drop in its fixed maturities portfolio and $1.87 billion during the first nine months of 2022 in unrealized investment gains and losses - fixed maturities. At the mid-point of 2022, Employers Holdings Inc. reported an unrealized drop in its second-quarter earnings. The Nevada-based carrier, which focuses on providing workers’ compensation coverage to employees at small businesses concentrated in low- and medium-risk industries, reported a net loss of $15.6 million in the quarter compared to a net income of $26.4 million in the same period a year earlier. The company reported a realized and unrealized investment loss of $50.1 million. For Assurant Inc., a New York property/ casualty carrier focused on covering major consumer purchases, the losses were more than just paper. In the third quarter, the company reported a 95% drop in net income to $7.3 million from $151 million a year earlier. Among the items cited by the company as a drag on earnings was “an increase in net realized losses from sales of fixed maturity securities.” “Many insurers probably don’t want to crystallize those losses. I think insurers are definitely going to have more flexibility on new premiums or new assets versus trying tor reallocate existing ones, especially if they are sitting on some unrealized losses.” Luke Schlafly PineBridge InvestmentsNext >