A Return to Normal
Introduction
I am pleased to write you in SBLI’s 117th year and a full four years post the COVID-19 pandemic and the ensuing financial rollercoaster as we returned to “normal”. I will take the opportunity in this year’s letter to report on how SBLI has and will continue to navigate these external mortality and market changes. That is not to minimize the critical work we do internally and in service to our customers to keep pace with technical advances and product evolutions. We are driving internally to continue to service all our policyholders in the manner in which they choose- from walking into our office, speaking to our agents, or conducting any process with self-service ease. We are also working on innovating our offerings to make sure we best align our product suite with current customer demands. All this work, along with our continued commitment to deliver exceptional care and service, are our greatest areas of focus. However, the external market in which we operate has increasingly added complexity to our ability to grow, innovate, price, and manage our business.
Prior to the pandemic, we felt a greater comfort in what was “normal.” The definition of normal is “conforming to a standard; usual, typical, or expected” result. That seems quite simple and straightforward. In essence, normal is what is expected based upon past experiences. Our perception of “normal” is guided by what is going on in the moment. As humans, we thrive at living in the here and now. We also thrive on comparing this time to the past to glean if it is what one should expect as normal. When one watches the weather on the news, the meteorologists consistently compare the day to “normal average” temperatures for the day. They also juxtapose the chances of setting a record low or record high for the day. Other aspects of the news do the same. The reports of the results of the stock market indices for the day similarly thrive on providing comparisons to “expected returns.”
In 2023, there were steps towards life returning to normal following the pandemic, but it requires a broadened lens. For us in the life insurance market, we have been monitoring closely how we are returning to normal in our mortality, interest rates, economy, and other key business factors. Four years later and with a wider view, we are seeing these factors normalize. For instance, let us look at interest rates. Many financial newscasters classified the surge in interest rates from 2022 to 2023 as resulting in “historically” high interest rates. They did segments on the mortgage market and classified rates over 7% for 30-year fixed rate mortgages as record highs. Both of those classifications could not be further from the truth; and one does not have to go back in time very far to dispel the reports. The 4.25% yield on the 10-year U.S. Treasury today compares to annual averages for the 1990s between 5.65% (1999) and 8.55% (1990). Mortgage rates for 30-year fixed rate loans ranged from 7.50% to 11.00% over the same time period. Mortgage rates in the 1980s exceeded 15%. While rates are definitely higher in 2023, they should be considered more normal than historically high.
As we look back at 2023, I will provide my perspective on what is normal and what remains changed and how we have been impacted at SBLI.
Mortality
After the U.S. suffered three years of declining of life expectancy from birth, we began to rebound in 2023; returning to our normal and expected upward trajectory. Life expectancy can be measured in multiple ways. Life expectancy at birth measures how long a baby born today could expect to live if all current expected causes of death remain consistent over that baby’s life. In 2023, that average improved to 77.5 years versus 76.4 years in 2022. For males, the expectation is 74.12 years and females improved to 79.78 years; both of those figures match the figures posted in 2009. However, over the fourteen-year stretch from 2009 to 2023, there have been improvements in traditional sources of mortality. Cancer survival rates and cardiac care have both improved; consistently contributing to improving mortality through the years. Conversely, the most recent past has been challenged by the opioid pandemic, elevated rates of suicided and COVID-19 related deaths. The skew lower for males versus females has been attributed to the fact that 68% of opioid related deaths are male.
Life insurers such as SBLI are keen to follow and must price-based on mortality trends overtime. To do this, we focus more on life expectancy as it relates to those already alive. The difference lies in expectations and assumptions. For life expectancy at birth, it assumes that all the causes of death at various ages will remain static. Thus, the elevated impact of COVID-19 from the past few years and opioid deaths from the past decade will remain elevated as these babies age and progress through their lives. It is a static model. The life expectancy of those already alive is more dynamic and is more prone to display the benefits of mortality improvements, especially now that COVID-19 related deaths have declined. SBLI’s mortality experience for 2023 was better than had been expected in our 2023 budget and appears to be returning to more normalized actuarial trendlines.
Financial Markets, the Economy, Interest Rates and Bank Failures
Financial Markets
The financial markets, as defined by the leading stock market indices had a wonderful year in 2023. The S&P 500 Index was up over 24% in 2023 which benefited investors passively invested in index funds. However, underlying that increase, 75% of stocks in the index underperformed while the “Magnificent 7” stocks provided blockbuster gains. The gain for 2023 compares to a loss of 19.44% in 2022.
SBLI and the life insurance industry at large do not have high percentages of funds invested in the stock market. In general, life insurers own much higher percentages of bonds. However, we still care about how the stock market is performing because of what is called the “wealth effect.” The wealth effect theory is one where individuals tend to spend more freely when their stock and real estate values are up because they feel wealthier. This drives positive economic activity and growth. Since the purchase of life insurance is a discretionary purchase, a positive wealth effect has a positive correlation to new life insurance purchases and continued payment of existing policies, both benefits to SBLI.
The wealth effect has had a growing influence and importance on driving the US economy and all discretionary purchases. Exposure to stocks for the average U.S. citizen has been growing since the creation of the 401(k) in the early 1980s. The percentage of U.S. households exposed to the stock market more than doubled in the 1980s from 15% in 1980 to 33% in 1989. By 2000, 60% of U.S. households owned stocks. Then, the recession just after the 9/11attacks caused enthusiasm in stocks to decline and the percentage dropped back to the low 50s. By 2008, the percentage climbed to a new record of 61%; just in time for the Great Financial Crisis to instill a crisis in confidence in stocks. Once again, the percentage dropped back below 50% and slowly climbed back to 53% by 2019. In 2023, the percentage of U.S. households who own stocks has reclaimed the record of 61% but on a much higher population. More than 158 million Americans own stocks today; making the wealth effect as powerful a factor as it ever has been for new life insurance purchases.
The Economy
The performance of the U.S. economy in 2023 was remarkable. As we entered 2023, virtually all major financial institutions and their teams of economists were predicting a recession. Their theory was higher interest rates, called for due to high inflation rates, would tighten monetary conditions and the inverted yield curve (short interest rates higher than long interest rates) was a strong indicator of a slowing economy. However, much to everyone’s surprise, the most anticipated recession of all time never materialized. Job growth remained strong, inflation eased, and economic growth remained positive.
Some of the theories about why the recession never materialized are as follows. First, most U.S. mortgages are set at fixed rates and have been financed at low rates over the past several years. For these individuals, higher interest rates do not have as much of an impact because their monthly mortgage payment has not changed. Second, job growth has cooled in several sectors of the private employment economy, but government hiring has been strong along with health care and hospitality. Third, U.S. households have much lower levels of debt than the past allowing borrowers to handle things better. However, this is of little consolation to those who are trying to purchase a home today.
Similar to my comments surrounding the wealth effect on purchases of life insurance, consumers’ feelings, and opinions of how the broader economy is doing has an impact on life insurance product purchases as well. A growing economy with low levels of unemployment are conducive to new life insurance purchases and continued payment from existing policyholders.
Interest Rates
The Federal Reserve continued to tighten monetary policy in 2023 by increasing the federal funds rate by 25 basis points at the February, March, and May meetings, bringing the target rate from 5.25% to 5.50%. The 10-year U.S. Treasury, which drives mortgage rates and is the benchmark for SBLI’s investments, began the year at 3.88%, climbed as high as 5.00% by mid-October and declined to 3.88% on December 31, 2023. Since December, that rate has climbed back up to 4.25% as of March 25, 2024.
The Federal Reserve’s activities of tightening (increasing) federal fund rates are designed to increase the cost of short-term borrowings in order to slow down demand and economic activity with an eye towards bringing inflation back down. They have a dual mandate of controlling inflation to a 2.00% target level while maintaining full employment, in essence a low unemployment rate. The Federal Reserve managing to increase rates to bring down inflation while simultaneously maintaining low unemployment has been call a “soft landing,” and is a very difficult task. To date they appear to have done so.
Similar to the wealth effect for the stock market and the economy, consumers’ perceptions of their ability to pay interest on their credit cards, car loans, mortgages and other debts impacts their decisions to spend money. Once again, with the purchase of life insurance being a discretionary purchase, SBLI is keenly aware of the impact that interest rates have on its product premiums, both new and renewal.
The other critical impact of higher interest rates to the Company is the positive impact higher rates have on its investment portfolio. Just one year of higher rates has taken pressure off of investment income due to the long-term, persistent low-rate environment. The relief from investment income overtime could allow from lower pricing, greater product diversification, enhanced services, and overall enhanced business strength.
Bank Failures
SBLI is the acronym that we use to represent The Savings Bank Mutual Life Insurance Company of Massachusetts. While the “B” stands for bank, that is in deference to our heritage and any commonalities end there. But, during periods of turmoil in the banking industry, we do field questions on whether we are a bank or not. It was no different in 2023 as banks came under pressure.
First, I will cover the why we are named Savings Bank Life Insurance. SBLI was founded by Louis Brandeis in 1907 in the middle of what was then the greatest financial crisis of all time, The Panic of 1907. The stock market had declined over 50%, bottoming in October of course. There was a run on the banks and many failed. J.P. Morgan stepped in to fund many banks and used his U.S. Steel company (acquired in a previous “panic”) to buyout large railroad companies that were in duress. And further, he provided $30 million to the City of New York to save it from filing for bankruptcy. He had made himself the “lender of last resort.” The politicians of the day feared that and began conversations about creating a central bank, The Federal Reserve Bank. J.P. Morgan went from being heralded as a savior of the banks and economy to being labeled an opportunist. He was in the midst of Congressional hearings about the 1907 bank failures when he died in March 1913. The Federal Reserve Bank was created on December 23, 1913.
Having seen abuses in the life insurance sector via the Armstrong Commission in 1905 and the witnessing the stresses of the Panic of 1907, Brandeis modeled SBLI to function as a provider of whole life insurance to the “common man” and exclusively through Massachusetts mutual savings banks. He believed that structure meant SBLI would always do what was in the best interest of the banks’ clients. For the next 100 plus years, SBLI had a close working relationship with the mutual savings banks of Massachusetts.
Fast forward to 2023, the Federal Reserve embarked on raising interest rates to slow down inflation. This caused short term rates to rise much faster than long term rates and some banks quickly found they were paying more for deposits (or borrowings) than they were earning on their loans and investments. They quickly began to lose money. Depositors became nervous and the classic “run on the bank” ensued. To put things in perspective, five banks failed in the US in 2023. Over the past 10 years, five banks have failed each year on average. It just happened that two of them were high profile and represented the second and third largest bank failures of all time. Prior to Silicon Valley Bank failing in March of 2023, the FDIC had gone 868 days without a failure, the second longest stretch since the FDIC’s creation in 1933.
As a life insurer, SBLI’s business model is significantly different than a bank. Simplistically, with a bank, they take in deposits and lend those funds to clients for loans. The difference between what they earn on their loans versus what they pay for their deposits (cost of funds) is a large contributor to how much money they make. Since deposits are short term in nature and loans longer term, a rapid rise in rates can cause deposit rates to equal or exceed that of loans, impacting profits. For SBLI, our “cost of funds” is embedded in the life insurance contracts that we have on our books. It does not go up or down when interest rates change in the market. It is more static over time for blocks of business. When interest rates go down, SBLI and other life insurers’ profits compress down on that embedded cost of funds. So, for SBLI, the increase in interest rates in 2022 and 2023 was a welcomed event because it allowed us to reinvest maturing securities at higher interest rates. This took pressure off of the compression in investment income from lower interest rates. Ironic given SBLI’s historical relations with banks, the higher rates that caused turmoil with the banks in 2023 was a benefit to SBLI.
Conclusion
SBLI operates in a complex world. We are impacted by changes in mortality, changes in the stock market, changes in the economy and changes in interest rates. The combination of these factors has a significant impact on our policyholders. From new customers buying from us today to our most longstanding policyholder, an insured with a juvenile whole life policy written in1930, our policyholders have broad influences we experience and manage.
I started this letter defining “normal.” We took some steps towards normal in 2023. Interest rates as measured by the 10-year U.S. Treasury yield are back to their long-term averages maintained for over 200 years. It will be odd to most of us alive, but 10-year U.S. treasury rates below 3% and above 6% are more of an exception than normal over most U.S. history. The yield curve remaining inverted is abnormal, but that too will correct itself at some point; maybe in 2024 when the Federal Reserve is expected to cut the federal funds rates.
Mortality appears to be returning to normal as well. COVID-19 attributed deaths in the U.S. peaked at 25,000 per week in early 2021 and stand at 1,318 per week today. At these levels, COVID-19 mortality is now roughly equivalent to a bad year of the seasonal flu. Eventually, I expected COVID-19 deaths to decline further and blend into the annual flu calculations.
In the end, our commitment to you, our SBLI Members, is for the management team and the Board of Directors to manage SBLI to the best of our abilities no matter what the issue of the day is. No matter what the challenge, we strive to meet it and persevere. For our Members, it has become normal for SBLI to exist as a company as it has since 1907. Our collective goal is for that to remain normal for the next 100 years and beyond.
Jim Morgan, President & CEO
OPNA 24-4123 (4/24)