#402 | The Long Tail of Portfolio Yields

Ever since interest rates started to increase in 2022, there has been much speculation about how long it would take to see material increases in carrier portfolio yields. The simple answer is that life insurers have an average maturity in their portfolios of around 10 years. Theoretically, that means it takes 10 years for the portfolio yield to match the “new normal” for market investment yields. In between, we’d expect to see marginal increases to policy credited rates (for UL/IUL) and dividend interest rates (Whole Life). That’s exactly what we’ve seen. Guardian, New York Life, MassMutual and Northwestern all put through modest increases to their Dividend Interest Rates last year. Pacific Life and Nationwide have been gradually increasing in-force crediting rates and IUL S&P 500 Caps. It looks like everything is more or less going to plan.

But looks can be deceiving. Reality is much more complex. Standard NAIC Blue Book reporting includes a disclosure that breaks down fixed income holdings by maturity buckets. The shortest bucket is less than one year, then 1-5 years, 5-10 years, 10-20 years and 20+ years. To calculate weighted average maturity (WAM), we coded the 0-1 year bucket as 0.5 years, the 1-5 year bucket as 3 years, the 5-10 year bucket as 7.5 years, the 10-20 year bucket as 15 years and the 20+ year bucket as 22 years. Here’s how the weighted average maturity compares for 23 life insurers where I had 2023 statutory financials on hand:

The average WAM across all 23 insurers is 10.63, pretty close to the general rule of thumb of 10, but the variance between insurers is huge. Accordia tips the scale with a massive 20 year WAM and Symetra clocks in with a WAM of just over 6 years. These two are instructive, I think, because Accordia’s reserves are entirely made up of life insurance and Symetra’s reserves are 90% annuities. Life insurance policies have a naturally longer lifespan than annuities, which tend to burn off at the end of the Surrender Charge period of between 2 and 10 years. It makes sense that Symetra’s WAM would be a lot shorter than Accordia’s because the liabilities are shorter.

But the nature of the liabilities doesn’t explain everything about differences in WAM. Consider, for example, that Global Atlantic also owns an annuity writer, Forethought, which is 95%+ annuities. Forethought’s mix of MYGA, FIA and Payout annuities looks pretty similar to Symetra’s, but it has a WAM of over 10 as of 2023. On top of that, Global Atlantic appears to be more actively managing Forethought’s WAM than Symetra, which has been consistently decreasing WAM since at least 2007. Forethought, by contrast, essentially loaded up on long bonds and then unloaded them as rates plummeted in 2021. Take a look at the WAM for each company over time:

More broadly, we see a similar effect in other annuity writers that have, at least theoretically, similar liability structures. You’d think that their mix of assets between short, mid and long-duration would also look fairly similar. In some cases, that’s true. But in other cases, it clearly isn’t. Take a look at the percentage of fixed income maturities in each bucket for 8 major insurers with the bulk of their assets in individual annuities:

There seem to be two different philosophies at play. Some companies actually invest primarily in short-duration assets – MassMutual Ascend, New York Life & Annuity, Symetra and American Equity (AEL). Forethought and Corebridge have more of a balanced approach across the durations. North American and Athene, however, take a totally different tack by investing long. What’s going on? There are a lot of potential explanations – reinsurance, liability structure, income rider business mix, floating rate securities – but I think Athene is instructive. Below is the same chart structure as above, but this time comparing Athene in 2022 and 2023.

How a company invests is partially about liability structure and partially about how to play (for lack of a better term) the interest rate environment. That may be the other reason why Athene went long on duration in 2023. They might be making an implicit bet on the interest rate environment. If rates drop, you want to be holding long-dated paper because the gains will be huge. The converse is true of rates increase. Given the current level of interest rates, it’s hard to argue against the idea that holding assets that have longer maturities than your liabilities has substantial downside risk.

However, these decisions have consequences. The same logic was also true in the mid-2010s when interest rates were ultra-low. If a carrier wanted to increase yield in a permanently low interest rate environment, one option was to invest very long. Case in point – Accordia, which was increasing WAM in the mid-2010s. Throughout that period of time, Accordia regularly sported some of the highest available S&P 500 Caps in the market. How was Accordia supporting those rates? Partially, as we’ve written before, by subsidization through policy charges. But the other angle appears to be that they were invested way longer than anyone else.

Accrodia’s WAM was a whopping 18.65 in 2020, higher than any other insurer by several years. They trimmed the WAM only slightly in 2021 to 16.26 by essentially shuffling $400 million out of 20+ year maturity assets and into 5-10 year assets. But in 2022, Accordia was still sitting with 89% of its assets in bonds with more than 10 year maturity and 64% in bonds with more than a 20 year maturity. The impact for policyholders is that they were essentially cut out from any participation in the rising rate environment because Accordia’s assets were stuck in long-maturity bonds. Given that asset growth at Accordia is essentially flat year-over-year, it could reasonably take 20+ years for policyholders to start to see the effect of higher interest rates flow through to actual policy crediting. It’s a terrible situation for policyholders. Accordia made exactly the wrong bet at exactly the wrong time. What was a strength because a weakness that cut so deep that it might have even been one of the reasons why Accordia decided to just close up shop. They probably knew what was coming.

How many other insurers are in the same situation? WAM is one metric of how quickly a life insurer’s portfolio will react to a changing interest rate environment, but it’s not the only one. Imagine, for example, a life insurer with 50% of its assets in <1 year maturity paper and 50% in 20+ year paper and a stable asset base. The carrier’s portfolio will respond quickly, but it’ll cap out because 50% of the assets are stuck. The 20+ year bucket is really, really important for understanding overall portfolio agility and responsiveness.

Below is the same table as the first one in the article, but this time with carriers ranked by allocation to the 20+ year maturity (in dark blue) and showing the 10-20 year maturity allocation in light blue above. With a scale max of 70%, Accordia is literally off the chart with a 76% allocation to 20+ year maturity bonds and an additional 21% to 10-20 year maturity bonds. I also removed the annuity writers because the effect of portfolio crediting is obviously irrelevant for those insurers.

On average, 50% of life insurer assets are invested with maturities greater than 10 years. The average allocation to 20+ year maturities is over 25%. The high-level talking point is that it’s going to take a long time – potentially a very long time – for portfolio yields to catch up to a persistently higher interest rate environment. We’ve already seen that to be the case. Rate increases on in-force blocks of business have been slow and unevenly distributed. The Big 4 mutuals all increased their DIRs last year by 10-15bps. That’s a fair indication of the current impact of rising rates given the fact that most of their money is still invested in older assets. Some companies have made similar moves for IUL caps, other companies have actually dropped IUL caps, as written in previous articles. Despite the fact that rates have stayed persistently high, carriers have generally stayed put in 2024. This isn’t a flaw. It’s a natural effect of the lag in portfolio yields – a lag that is going to be much longer and much more painful than most people thought.

The potential mitigating factor is turnover. If a company is growing rapidly, then there’s an argument to be made that the response in the overall portfolio will be faster because new money will more quickly dilute the effect of assets invested in long-maturity bonds at the wrong time. But the average asset growth for the life insurers above is just under 2%. The reality is that for all but a handful of outlying companies where growth is so huge that it will overwhelm the effect of previously invested assets, the portfolio rate going forward will be determined by old money, not new.

As I’ve written before, I think traditional Whole Life can maintain its appeal by pivoting the story to the asset class characteristics of the products and the benefits of mutuality. I’ve also written that despite the obvious challenges for indexed crediting due to lower Caps relative to risk-free interest rates, it too can still tell the core story of downside protection and upside potential, particularly if the indexed account is available in a Variable UL policy where the client has allocation flexibility. The entire industry benefited from consistently falling interest rates because our products delivered blockbuster returns well in excess of the norm. And now the bill is coming due.

This is very bad news for the premium financing complex that is largely built on the presumption of long-term “arbitrage” between the cost of borrowing and the policy performance net of charges. That “arbitrage” no longer exists. In some situations for in-force policies, the current cost of borrowing exceeds the available S&P 500 Cap. To counteract this effect, premium financing vendors have deployed two stories. First, as covered in previous articles, is to predict that rates will drop. Almost without exception, every premium financing proposal that I’ve seen over the past couple of years has shown a declining interest rate assumption. This is foolish, dangerous and fodder for future litigation. When rates were low, premium financing vendors were more than happy to project that environment forever. Now that rates are high, premium financing vendors are ignoring the current environment and reverting back to an assumption of low rates.

The second, which is also sometimes used as justification for showing low rates, is to assume that Caps are going to increase. Consider the comically simplistic video released by NIW to explain why the Kai-Zen program, which is a down-market version of premium financing, is “built” for rising interest rates. As the video explains:

“While rising interest rates can be tough for many investments, they’re actually great news for Kai-Zen. Here’s why…when interest rates are low, as they have been for a while, the caps and returns on IUL tend to fall. But when the [interest] rates go up, so do the caps. And that translates into the ability to capture more of the index upside. Although cap increases can lag behind interest rate changes, our carrier partners have already raised the caps twice in 2022 and will continue to adjust as we move forward…while a rapid rate rise may have a short-term negative impact, the caps have historically caught up to rebalance the plan…and here’s where it gets interesting. As interest rates rise, so do the caps, providing a greater opportunity to capture more of the market upside during a rebound.”

There are elements of truth in the video. Caps do lag. A rapid increase in interest rates does have a short-term negative impact. But the overwhelming message is to Keep Calm and Kai-Zen On. Why? Because carriers will increase the caps and things will get back to “normal,” which is perpetual arbitrage forever. Never mind the fact that the lag in caps could take 20+ years. Never mind that option prices increase as rates rise, which means caps may actually drop. Never mind that most of the Kai-Zen programs I’ve seen actually use engineered indices with participation rates, not caps. Never mind that the cap increases referenced in the video may have only been for new policyholders, not existing ones. And, of course, never mind the fuzzy connection between interest rates and market returns, which the video switches around at various points in support of the overall argument.

I don’t think the Kai-Zen argument is unique. The only thing that’s unique about Kai-Zen is that it has so many participants in the standardized plan – rumored to be in excess of 10,000 – that they felt the need to put out a video to explain the mechanics. Other firms that focus on the traditional premium financing space filled with high net worth clients and large transactions are telling the same story, they’re just not putting it on Vimeo. Almost everyone that sold premium financing on the basis of long-term perpetual arbitrage seems to be buying time by telling a story that is not only vaguely and selectively supported by the facts. With SOFR stubbornly at or near record highs and rate relief slow in coming, the clock is ticking.