Recent government data reveals a surge in the value of the U.S. dollar against other currencies since July 2023. While this brings positive implications for U.S. consumers, there are both favorable and unfavorable aspects to consider. On the downside, the strength of the dollar can diminish the earnings of insurers, specifically an annuity issuer, generated outside the United States.
Additionally, it may have adverse effects on an insurer’s reserves, especially if its investment portfolio is heavily invested in international stocks or bonds. As such, annuity owners should be vigilant about foreign exchange risks impacting their investments.
Why Do Annuity Issuers Have Foreign Exchange Risk?
Insurance companies with international operations settle claims to beneficiaries in the local currency of the respective foreign markets. To fulfill claims in these markets, U.S. insurers are required to sell U.S. dollars and convert them into the relevant local currencies.
However, engaging in foreign currency trading goes beyond meeting overseas claims for annuity issuers. The funds generated from international activities eventually need to be repatriated to the United States. The strength of the U.S. dollar plays a crucial role in determining the value of these foreign earnings, and when the dollar is robust, it can impact the relative value of such earnings.
How Annuity Insurers Are Impacted by a Strong Dollar
Even annuity issuers without international business operations can face the impact of a strong dollar, as their foreign exchange risk may be concealed within their investment portfolios.
This is particularly relevant if these issuers hold international or emerging market stocks. Global investments often underperform when the U.S. dollar is robust.
According to the International Monetary Fund, a 10% appreciation of the U.S. dollar in emerging market economies can result in a 1.9% decrease in economic output after one year, with the negative effects persisting for over two years.
The risks extend beyond emerging market stocks. An annuity provider investing in large multinational companies also exposes itself to foreign exchange risk.
A strong dollar diminishes the value of revenue generated overseas when converted from local currencies back to U.S. dollars. The rise in the dollar can lead to a decline in American exports, making U.S. products more expensive in foreign markets.
These factors can adversely impact the revenues of American companies, leading to a drop in stock prices. Lower stock prices have the potential to erode an insurance company’s reserves, which are important for meeting annuity payments.
Why Annuity Owners Should Not Fear a Strong Dollar
According to the National Association of Insurance Commissioners (NAIC), American annuity providers generally maintain limited exposures to foreign stocks or bonds, and this exposure has been steadily decreasing since 2018.
In a separate report, NAIC highlighted that for insurance companies, including those issuing annuities, “[U.S.] bonds continue to be the largest component [of their portfolios], representing 62.3% of total cash and invested assets.”
Over the past few years, insurance companies have consistently maintained a mid-teens (12% to 15%) allocation to common stocks. Notably, their exposure to foreign investments has seen a substantial decline of nearly 44% between 2012 and 2022.
Of the remaining foreign investments in portfolios, more than 90% are in bonds. The majority of insurers’ investments are in U.S. bonds, which contribute to the income passed on to annuity owners.
Given these portfolio compositions, a strong dollar is unlikely to pose significant risks to the investment reserves of most annuity issuers.
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