Copyright 2009 A.M. Best Company, Inc.All Rights Reserved BestWire

March 3, 2009 Tuesday 09:57 AM EST

910 words


Living Benefit Guarantees in Variable Annuities Now Cost More and Protect Less

Ronald J Panko

OLDWICK, N.J.

According to a research report by consulting firm Milliman Inc., hedging was about 93% effective through October and saved the life industry about $40 billion money it otherwise would have had to account for in earnings and capital. And with stock prices collapsing, hedging programs protected variable annuity writers from the effects of sinking account values, which shrink asset-based revenues.

Hedging costs have been rising, however, and insurers are adjusting both the benefit levels and the amounts they charge policyholders to reflect the new realities, according to actuary and financial analyst Peter Sun, who co-authored the Milliman report with Ken Mungan.

The VA industry has long claimed that guaranteed living benefits boost sales. Axa-Equitable introduced the first living benefit in 1996, a minimum-income feature that guaranteed annual growth in future income until annuitization took place and regular income payments began. More recent benefits that do not require annuitization include guaranteed minimum withdrawal benefits, minimum withdrawal benefits for life and minimum accumulation benefits in the account value.

Hedging actually results in cash payments to VA writers from counterparties to equity futures and interest-rate futures. These futures contracts are sensitive to volatility, and they have become more expensive. Sun said many insurers are responding with some combination of raising the charges for the guarantees or reducing the benefit levels.

Dan Beatrice, an analyst in the retirement research unit at Limra International, said such changes have become common and that the fee increases are often 15 to 30 basis points of the benefit base. Benefit reductions commonly come in the form of slower accrual of the benefit base before policyholders begin the guaranteed payments or the withdrawals, he said.

VA writers also are paying more attention to potential vulnerability to leakage in their hedging programs, Sun said. In particular, writers realize there are limits to the equity allocation that can be included in a guaranteed product because of the need for reasonably close tracking between funds in a guaranteed product and its hedge indexes. Without close tracking, VA writers face what he calls a "basis risk," meaning that the performance of the investment options lags its hedge index.

Sun said this can occur when actively managed funds incur higher expenses due to increased rebalancing, or when the composition of the indexes changes. "If you think about the composition of the S&P 500, financial stocks now make up much less than they did just half a year ago," he said.

Compared with other financial-services companies making guarantees, VA writers usually have time on their side as to when they have to make good on them. Variable-annuity guarantees are not usually liquid, and buyers of deferred annuities may hold onto them for many years before they annuitize and begin a payment stream.

admin
Buyers of withdrawal benefits often must wait 10 years before they may begin withdrawals, and companies usually guarantee annual growth of the benefit base during that period. And as Beatrice pointed out, withdrawals locked in at annual rates of 5% or 6% of the benefit base at the time of election would take 16 to 20 years to deplete that base.

Effects on Sales

VA sales already had fallen 18.1% to $37.8 billion in the third quarter of 2008, according to Morningstar Inc. and NAVA, the Association for Insured Retirement Solutions. Would the product changes hurt sales even more? Sun didn't know, but he said not having guarantees would make things worse.

Actually, the success of the living-benefit guarantees may actually cause sales to decline in the short run. As Beatrice pointed out, tax-free replacements of old variable annuities with new ones have represented the vast majority of sales in recent years. Now, however, with so many contracts "in the money," meaning that the guaranteed amounts exceed the contract values, policyholders would likely be reluctant to surrender such policies.

"It's reasonable to expect that there will be less of an opportunity for those sales, and that could drive down industry sales figures in 2009," he said.

Sales traditionally correlate very strongly with the equity markets. So if equities appear to have bottomed out and then improve through this year, sales could likewise improve, Beatrice said.

"One of the interesting things to me is that in the popular press, we often see criticisms of annuities," he said. "Recently, they have shifted from offering guarantees you don't need, to 'Geez, it's a great guarantee, but we don't know if the companies can deliver on them.' I think the companies are going to deliver on them, and if people see those guarantees as a demonstrated value, then we have the opportunity for a good sales story in 2009."

Catherine Weatherford, NAVA's president and chief executive officer, said insurers did a "fabulous" job with living benefits. "They proved in the perfect storm, in the most volatile time, that their strategies, planning and hedging worked, even in a scenario that I don't think anyone contemplated," she said.

"Having now seen the worst-case scenario, the industry is going to learn from this economic crisis and collapse of the marketplace and refine and improve its products to make them even more valuable to the investor of the future." Weatherford characterized the current benefit changes as a "tweaking."

(by Ron Panko)

March 4, 2009

Copyright © 2009 LexisNexis, a division of Reed Elsevier Inc. All Rights Reserved.
Terms and Conditions Privacy Policy