Fitch Ratings has revised its outlook for the U.S. life insurance sector to negative from stable, citing the significant deterioration in the credit and equity markets and the expected impact of realized and unrealized investment losses on life insurers’ capital levels and profitability.

The rating agency says that the move to a negative outlook reflects ongoing concern about the industry’s expanding equity market exposure, driven by growth in variable annuities, which can add significant volatility to financial performance and capital in a period of unstable market conditions. Also, for some life insurers, Fitch is concerned that liquidity pressures could develop if capital markets remain unstable and funding needs cannot be met.

Fitch’s movement to a negative industry outlook implies that it expects more downgrades than upgrades across the U.S. life insurance industry over the next 12 to-18 months. However, it does not imply that all, or even a majority, of life insurers’ ratings will necessarily be downgraded.

Although less exposed to market issues than many investment banks, commercial banks, or financial guarantors, life insurers are experiencing a significant deterioration in investment results, which has negatively impacted industry earnings and capital, Fitch reports.

In the first half of 2008, Fitch’s universe of life insurers reported combined statutory net income of US$2.2 billion compared to US$28.6 billion for full year 2007. It expects earnings to deteriorate further in the second half of 2008 and into 2009 driven by increased investment losses.

In addition, Fitch expects the deterioration in industry capital levels, which declined an estimated 4% in the first half, will accelerate in he second half. This will be driven by greater recognition of unrealized investment losses.

Despite these pressures, Fitch notes that the U.S. life insurance industry is relatively well positioned to weather an environment of capital markets volatility and market illiquidity.