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Last week, the Federal Reserve acknowledged that inflation appears to be a bigger concern than originally assumed. The Fed also made clear its tentative plans to pull back on interest rate easing sooner than planned. This means interest rates will likely trend higher in the near-ish future, which could be good news for life insurers. Life insurers, who largely invest in bonds, presumably welcome any news that suggests yields might be higher than they are today.
But if the Fed pulls back on buying treasuries and we see bond yields rise, are any of the major life insurers who sell whole life insurance ready to take immediate action on this new economic circumstance? So we set out to identify any insurers who were.
How Life Insurance Companies Buy Bonds
Life insurers use the premiums they collect from policyholders as the key source of funds to buy assets. Bonds comprise the majority of these assets. But life insurers do not trade bonds. Instead, they hold these bonds to maturity–benefiting from the income provided by the bond.
To use a way oversimplified example, let's say you own a whole life policy with a $20,000 annual premium. Each year, you pay the insurance company $20,000. The insurer takes that $20,000 and uses most of it to purchase additional assets–the majority of which are bonds. The exact mix of bonds the insurer will buy depends on way too many circumstances to dive into here, but whatever the maturities they decide on, the insurer will live with.
There's a risk that all insurers undertake while doing this. There's a chance that in the near future, the insurer could have bought bonds with your money that paid higher yields. This fact, and the desire of the life insurer to maximize return with the dollars it collects from you, is one of the key factors that influence the mix of maturities the insurer decides to buy. If the insurance company thinks yields will go down in the future, it will buy a larger mix of longer-duration bonds. If it thinks yields are going up, it will buy a mix of shorter-duration bonds.
Those with a background in bond trading may incorrectly assume that insurers are trying to minimize un-realized capital losses, but their strategy to hold to maturity makes this an all most insignificant thought. Even the specialized accounting methods used by insurers to evaluate their overall financial health largely ignore the day-to-day market value of bond holdings in favor of the overall value the bond represents throughout its lifetime–i.e., its yield to maturity.
The subtle but critical point in all of this is that the speed at which an insurer can change its bond maturity mix is entirely dependent on the strategy it set in the past regarding the mix of bond maturities it bought. This is because to buy new bonds with new–in this case higher–maturities, the insurer mostly needs either new premium to come in or old bonds to reach maturity.
But…
Insurers have known for some time that yields are low and eventually trends should reverse. So maybe some of them held onto cash or lower maturity bonds to ready themselves for a bond-buying bonanza as soon as yields ticked up.
Looking at Life Insurer Cash and Liquidity Positions
We compiled accounting data from 11 well-known life insurers, all known for making whole life insurance a large part of the business they conduct each year. We then looked at the amount of cash and short-term–i.e., under 1-year maturity–bonds they held relative to the overall assets in the General Account.
The theory here is that a higher percentage of cash and short-term bonds indicates someone with a greater ability to seize the opportunity to take advantage of rising interest rates. What cash and short-term bonds position is adequate to really capture the moment? We have no idea since this all-new territory for all of us. But we can use traditional statistical methods and draw from our experience in the insurance industry to identify what might be an advantageous position.
Here are the results:
| Company | Cash and T-Bills to GA Assets |
| Ohio National | 8.67% |
| MTL | 8.64% |
| MassMutual | 6.29% |
| New York Life | 6.06% |
| Penn Mutual | 5.92% |
| NLG Vermont | 5.59% |
| Ameritas | 5.19% |
| Lafayette Life | 5.14% |
| Northwestern Mutual | 5.02% |
| Security Mutual | 3.80% |
| Guardian | 3.28% |
At first glance, it's tempting to declare that Ohio National holds the best position and Guardian the worst, but that may be a rush-to-judgment error. It's been a long time since the last time insurers and our overall economy faced the reality of rising interest rates, so practically speaking, we're all pretty much doing this for the first time. But, unfortunately, there's nothing I know about insurance company investment strategy that provides any insight into these numbers and how they may or may not position any of these life insurers to seize an opportunity regarding rising interest rates.
So let's consider some additional data about these numbers to try and gain some insight.
The average cash and short-term bond position of the group is 5.78%. Understanding that some of these insurers are considerably larger than others, it's prudent to also look at the weighted average to ensure there isn't an anomaly created by the size of the insurer's asset pool. The weighted average is 5.69%–more than close enough to reject the idea that the insurer's asset pool size heavily influences this data.
The standard deviation of this group is 1.69%. This means all of these results fall within a “normal” category, and no one looks particularly flush with cash nor seriously low.
Several factors might play into why an insurer's cash position is higher or lower than another. However, planning to buy new bonds at higher maturities is not a major consideration for any of those typical reasons. Since we don't see anything that looks unusual, it's reasonably fair to say that none of these current hoards cash with plans to buy new higher-yielding bonds.
A Look at Slightly Longer Maturities
Interestingly, if we look at slightly longer maturities–those in the 1 to 5-year range–we find minimal variation among this group of insurers. This category of bonds comprises roughly the same percentage of overall bonds they hold for all of them. It also tends to be the largest or second-largest percentage of their bond holdings. The other large category is bonds with significantly higher maturities–around 20 years. This is not unusual behavior. Insurers have long implemented the “barbell” investing strategy, which involves concentrating most of their holdings in very long and very short maturities. This generally provides the greatest amount of yield and the greatest amount of liquidity.
This strategy does appear to be shifted up slightly, favoring bonds in a short/intermediate maturity range versus an extremely short maturity range. This is most likely a result of the low-interest rate environment that persisted over the past decade.
But this strategy does make intuitive sense. Insurers hold fewer bonds in the extremely short duration range because the yield is poor. But they aren't going to concentrate all of their holdings in longer-duration bonds. The yield might be better, but they cannot lock themselves into a difficult-to-exit strategy when interest rates rise. So they instead use a duration timeline that commits them slightly longer, with a slightly better yield. As these bonds mature, the insurer can begin buying up new bonds with rising yields. Every one of these insurers displays a nearly identical investment strategy in this regard.
So Who is Best Positioned for Inflation?
While I'm sure everyone would like a concise datapoint to weed out who among the crowd holds the strongest position to benefit from rising interest rates. Unfortunately, the data doesn't provide such an answer. Instead, it suggests they are all orchestrating a similar strategy and–if they are collectively correct–they all might be well-positioned.
While the investment component of the dividend is by far the most meaningful, have you considered the differences in expenses and mortality among the better insurers? These differences have a lot of years to compound during the life of an insurance contract.
We have thought about and discussed in the past. There are certainly insurers whose expenses weigh down performance, and there are even problems one can run into with blending one some insurers with higher term insurance costs that can hurt more performance.