Like many industries, the life insurance industry has taken a beating in the current economic recession. In recent months, some life insurers have had their debt ratings downgraded and seen their stock prices drop dramatically.

A sobering new report from Standard and Poor's states: "The volatile and depressed equity markets are making it difficult for North American life insurers with variable annuity business to maintain their financial strength. The market downturn is resulting in depressed asset-based fee revenue derived from variable annuity account values, sharply higher liability and capital requirements for variable annuity equity-based guaranteed minimum death benefits and living benefits, and increased hedging costs."

It adds, "So far, companies largely have been able to manage these risks. But, significant further declines in equity markets from year-end 2008 levels, if sustained, could adversely affect both capitalization and operating performance, and significantly accelerate the erosion of insurer financial strength, attributable to variable annuity risks."

On Feb. 26, Standard and Poor's announced downgrades in the financial strength ratings for 10 groups of life insurers and downgrades in the counterparty credit ratings on seven life insurance holding companies.

The downgraded insurers "had operating earnings that fell short of our expectations and showed increased volatility. The depressed equity markets have driven the lower level of operating earnings, resulting in lower asset-based fees, higher costs associated with guaranteed benefits, increased write-offs of deferred acquisition costs, and reduced net investment income," the ratings agency stated.

"The pressures within the life sector have been building. In October 2008, we revised our outlook on the U.S. life insurance industry to negative from stable, based on poor financial market conditions and the likelihood of a prolonged period of weaker-than-expected economic conditions. The outlook remains negative ... We believe that life insurers' bond holdings, commercial mortgages and commercial mortgage-backed securities could experience unprecedented stress in the next 12 to 18 months."

Mike Weintraub, a board member of the LIFE Foundation and president of Contemporary Pensions and Insurance Services Inc., is more optimistic: "There will be continued volatility in the market, but I think it will be more positive than in 2008."

Life insurers will see a drop in their premium revenue this year because premiums are usually based on a percentage of salary, and many employers are reducing salaries and raises this year, according to Scott Beliveau, vice president of life and disability at Sun Life Financial, a provider of group life insurance.

However, "the group [life insurance] business isn't affected" as much as non-group products have been affected by the downswing in the national economy, Beliveau asserts.

"In the group insurance world, those financial issues are not as prevalent." That's because the group insurance business model is based on mortality rates, employment rates and spreading out risk. In addition, the group plans are less susceptible to swings in the stock market because they typically have fewer investments in stocks and more investments in bonds, compared to other types of insurance, he adds.

Weintraub agrees: "Most of the life companies were not investing in a lot of the troubled mortgages. The life companies are actually pretty strong after the economy's gone through what it has. They're mostly investing in pretty secure bonds. That's where the bulk of the portfolios lie."

On a positive note, Standard and Poor's adds: "We continue to believe the credit fundamentals of the life insurance industry are strong. We believe the U.S. life insurance sector remains well-capitalized (even considering the incremental asset stress factors), maintains solid businesses, produces strong (albeit lower than historical) earnings and maintains strong liquidity ... Despite the unfavorable market, we believe the life insurance industry is generally well-positioned to meet its funding requirements.

"Companies are maintaining excess liquidity in these uncertain times. So far, financial leverage and coverage ratios are within tolerances for the ratings, and most have modest amounts of debt coming due in the second half of 2009 and into 2010."

'Do due diligence'

Now may be the time for employers to take a closer look at the financial health and solvency of their life insurer.

"HR people need to do their due diligence and make sure the carriers they're working with have strong ratings, and take a closer look at the investments that the insurance companies are making and make sure those investments are allocated properly and reserved well," Weintraub says. "Check with the various ratings agencies that are doing a very good job of due diligence to make sure that the companies are able to pay claims."

The ratings agencies include Fitch, A.M. Best, Standard and Poor's, and Moody's. Another option is to look at the firm's Comdex score, which is a composite of the ratings the firm has received.

"Select a company that has good financial strength as measured by third-party organizations. You want to know that your life insurer is going to be around many, many years from now," Beliveau advises.

Shift toward voluntary

Due to financial strains, employers are re-evaluating plan design, cost structure and communication strategies for life insurance benefits, according to Bob Reiff, a senior vice president in the group benefits division of The Hartford, which sells life insurance.

Between 2007 and 2008, the firm saw a 71% increase in presale strategy events (where employers evaluated their options), and a 38% increase in onsite enrollment events.

Some employers are shifting the cost to employees. "In this time, when employers need to cut expenses, every dollar helps," Beliveau says. "We've been seeing a shift toward voluntary [benefits] in the industry as a whole. I suspect that the economy will accelerate that. It's too early to say with any certainty any cause and effect."

Likewise, Reiff predicts that more employers will shift life insurance to a voluntary offering. "We have seen a greater interest in voluntary products in general," he says. About 92% of employers offer life insurance for employees, and 63% offer life insurance for employees' dependents, according to the Society for Human Resource Management.

In the private sector, 59% of workers have access to life insurance benefits, and the participation rate is 96%. In the public sector, 79% of employees have access to life insurance benefits, and the participation rate is 97%, according to the U.S. Bureau of Labor Statistics.

Life insurers are watching to see if layoffs and other financial hardships cause people to give up their life insurance. So far, Reiff says he has not seen a trend of employees dropping their life insurance; just the opposite occurred. "Our participation levels have improved," he says.

Some employees appear to be moving their money out of mutual funds and stocks, and into life coverage. Weintraub observes, "We're seeing more and more clients. People are actually looking at life insurers as a way to stabilize their portfolio. People are actually going to the life companies now to get that extra stability."