Are Annuities Too Risky for Insurance Companies?

Sun Life Financial breathes sigh of relief in sale to Guggenheim Partners.

Are annuities too tough a business for insurance companies to be involved in?

The question naturally arises from Canadian life insurer Sun Life Financial’s decision to unload its U.S. annuity business through a $1.35 billion sale to Guggenheim Partners’ Delaware Life Holdings unit.

Notably de-emphasized in its announcement on Monday was the usual corporate ballyhoo about profit taking; rather, the company’s news release was mainly about risk reduction and seemed only to omit the word “Pheww!” in announcing the sale.

“This transaction represents a transformational change for Sun Life,” the company’s CEO, Dean Connor, was quoted as saying. “It significantly advances our strategy of reducing Sun Life’s risk profile and earnings volatility, focuses our U.S. operations on our areas of greatest strength and opportunity, and crystallizes future earnings and capital releases that will further support our growth and shareholder value creation.”

Steve Cooperstein, a California-based actuary and strategic marketing and product development consultant, told AdvisorOne that the sale brings to light the difficulties of operating an annuities business profitably.

“It has to do with regulation and the amount of capital they have to put up behind the instruments they have to hold,” he said. “It makes it capital intensive and not as profitable because you have to hold back that capital.”

Cooperstein added that the financial downturn of the past several years has also exposed the fault lines of operating in this business, namely the difficulty of fully hedging risks.

“Actuaries are Johnny-Come-Latelys to the markets and to the whole field of hedging. It is a risky endeavor to try to hedge whatever you’re guaranteeing. Insurance companies have big downside risks if these hedges don’t work. I think companies are just seeing that. Companies are pulling back from these things, increasing their rates.

The high level of financial risk was reflected in Moody’s reaction to the news, downgrading Sun Life’s U.S. subsidiary “in anticipation of the removal of financial support from SLF upon the transaction's closing” while affirming the rating of Sun Life’s Canadian operations, saying the sale alleviates concerns the U.S. operation will remain a drag on earnings.

Moody’s put Sun Life’s Canada-based holding company on review for upgrade, saying the proposed transaction “is positive to the credit profile of SLF as it will eliminate the group's exposure to the chronically poor earnings performance of the U.S. subsidiary, possibility of future charges associated with the U.S. subsidiary's business, as well as the equity market and interest rate sensitivity of the run-off businesses.”

Mike Henkel of Achaean Financial, a developer of retirement advice software, agreed with Cooperstein that variable annuities are especially challenging to hedge.

Mike Henkel“While they’re nominally an insurance wrapper, they’re more like structured notes than an annuity,” he told AdvisorOne.

“Insurance is a pooling thing. We all put our money in and if the house burns we all pay for the house that burned down,” Henkel (left) says.

But there’s no pooling with variable annuities, he added.

“As such, the insurance companies have to do things differently. They have to hedge.

“Depending on the type of policy – GLWB [or others] – they promise to give investors some guaranteed payment stream for a long time. If you’ve got the right assumptions about longevity, the insurance company can make money off it,” Henkel says.

As for the buyer, Guggenheim Partners, Henkel speculates:

“They’ve either got a price that’s low enough that they think they can live with it; or they think the behavior of policyholders will be different than Sun Life thinks; or they operate under different capital requirements because it’s a U.S. business (rather than one based in Canada, which has strict hedging requirements).

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