Special Report from Best: Increase in Commercial Mortgage Holdings of US Life/Annuity Insurers; Declining credit quality

OLDWICK, NJ–(BUSINESS WIRE)–U.S. life/annuity insurance companies continued to increase their exposure to commercial mortgages in 2019 and now hold more than $522 billion, up significantly from $382 billion in 2015, according to a report. new AM Best special report.

the Best Special Report, titled “Commercial Mortgages Rise, Credit Quality Falls,” notes that U.S. economic fundamentals have been generally supportive throughout 2019, with continued GDP growth, low unemployment and rising retail sales . All of these factors have led to stable commercial real estate rents and stable vacancy rates. However, more recent trends for Commercial Mortgage (CML) properties show decreases in office and retail buildings and increases in apartment buildings. Developments related to COVID-19 could lead to further percentage declines in these holdings. Holdings in hotels and motels, which account for about 4% of L/A insurers’ CML investments, will also likely be under pressure until economies reopen more fully.

Despite the increase in holdings, including an 8% year-over-year increase in 2019, the percentage of prime loans with the highest rating, designated CM-1, has steadily declined, while the percentage of loans designated CM-2 has grown. The shift to CM-2 loans appears to be due to insurers’ efforts to increase yield, rather than deteriorating conditions leading to downgrades.

AM Best’s recent COVID-19 stress tests on its rated companies assumed declines in several asset classes, including a 10% decline in reported CML values, with those declines reducing the surplus, adjusted for taxes. CML’s valuation declines will impact Best’s capital adequacy ratio (BCAR) results, particularly for property types most impacted by the COVID-19 closures. Hotel properties, in particular, are experiencing unprecedented vacancy rates. Commercial and office properties are also experiencing significant declines in income, which can lead to deterioration in quality and lower valuations. It will also affect the performance of other mortgage-backed assets, such as commercial mortgage-backed securities. A prolonged impact of COVID-19 could also have a significant effect on loan values ​​and operating income for most property types.

As the pandemic drives loan forbearance, along with remote workers and travel restrictions, the potential for deterioration in credit quality increases. However, the low exposure of L/A insurers to hotels will help minimize the impact. Instead, insurers will feel the impact of longer-term pandemic conditions through accelerated loss recognition, which will put pressure on GAAP earnings. AM Best will closely monitor insurers with higher CML exposures relative to total statutory surplus.

To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=298550.

AM Best is a global credit rating agency, news publisher and data analytics provider specializing in the insurance industry. Headquartered in the United States, the company does business in more than 100 countries with regional offices in New York, London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City. For more information, visit www.ambest.com.

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