The economic capital adequacy of the U.S. life insurance industry declined in 2001, according to a new report released by Moody’s Investors Service.

“Although we still believe that the US life insurance industry has adequate capital to support its risks,” says analyst Robert Blanchard, the report’s author, “some downward rating pressure on the industry is likely to occur if recent trends persist.”

The reports says that the weakening of the industry’s capital adequacy was driven by reduced operating income, higher credit losses on investments, and
increased dividends paid to holding companies – all occurring while general account liabilities grew almost 10%.

The rating agency says it is concerned that continued turmoil in the financial markets, potentially at the expense of their companies’ creditworthiness, could put further strain on the industry’s already reduced capital base.

“The capital adequacy of the industry as a whole, however, was clearly weakened during 2001, although we believe the accounting and RBC changes must be evaluated on a company-by-company basis,” says Blanchard. “We
therefore believe that the favorable improvement in reported RBC actually masks the industry’s relatively more fragile capital position,” he states.

“When Moody’s attempted to ‘re-benchmark’ this key financial ratio for comparability across reporting periods so as to understand the sources of
the increase in reported RBC, however, it soon became evident that the economic capital – or the true available capital and financial flexibility –
of the industry had actually declined during 2001, contrary to the reported numbers,” says Blanchard. In addition, he says, the economic environment
and credit losses observed through the first half of 2002, which are expected to show little improvement in the coming months, will constrain the future growth of U.S. life insurer’s economic capital over the near-term.

“There has also been and will likely continue to be pressure from stockholders for companies to at least maintain their targeted ROE’s during this difficult market period.” Shareholder pressure is likely to result in a squeeze on the capital base of the industry through manager’s potential use of additional debt and share buyback programs to boost ROE, says Blanchard, a trend that has been amplified by several years of demutualization.