Dont Lose Sight Of A Key VA Aspect

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With all of the recent downside activity in the financial markets, it is important that sales reps, end-customers, financial analysts, and company management not lose sight of a key aspect of variable insurance products.

Namely, such products are maintained in insulated, unitized separate accounts. The assets and liabilities of an insurers separate accounts are directly associated with sales of specific insurance contracts. Each separate account carries its own set of financial statements, valued at market, as will be described later.

In nearly all states, insurers can structure their separate accounts such that the assets in these accounts are inaccessible to general creditors and cannot be used to pay for obligations arising from sources other than the policies funded through the separate accounts. It appears that such insulation has been recognized as valid in prior insurance company insolvencies.

Variable annuities and variable life insurance contracts are typically funded through unitized (i.e., daily unit values) separate accounts. This structure works well for these products in that fluctuations in the market value of the variable assets and liabilities are reflected directly in the separate accounts balance sheet, with the policyholder assuming the risk of appreciation or depreciation in asset values.

Given that the assets and liabilities of the separate account generally move in tandem with market fluctuations, the surplus of the separate account will tend to exhibit stability. By definition, then, the policyholders account value will be backed by corresponding assets in the separate account which can be structured with insulation from any other liabilities.

Some market value-adjusted annuities are also funded through a separate account (this time, a non-unitized separate account). Often, the assets and liabilities of the separate account supporting MVAs are reported at market value, providing some of the same coordinated relationship between the policyholders account value and the underlying market value of assets.

Certain variable products provide for contractual guarantees over and above the policys contract market value. Examples are the guaranteed minimum death and living benefits featured on variable annuities, and no-lapse features on variable universal life. In these situations, however, the excess risk (above a return of contract value) is reserved in the insurers general account, or else it is ceded to a reinsurer. The separate account is not looked to as the source of reserve support for such guarantees. The general account more broadly provides for the liabilities of “book-value” contracts, in which investment risk is passed to the insurer, and for all residual company liabilities.

As sales reps, policyholders, and analysts assess the financial solidity of various insurance carriers, it is important that they understand the relative amounts of separate account and general account risk exposure taken on by a given insurer. An insurer who sells variable products exclusively, with no (or modest) overlying guarantees, should require lower absolute levels of capitalization than an insurer with substantial book-value exposure and generous guarantees on their variable products. This difference has, in fact, been recognized in the benchmark capital requirements defined by the NAIC and rating agencies. Even in the case of a carrier providing material guarantees on variable contracts, the rigorous reserve requirements of some states, relative to posting liabilities for these overlying guarantees, creates additional layers of conservatism.

Although a significant component of the insurers risk has been removed from variable separate account business (i.e., the asset/liability mismatch and market value disparity risk), this is not to suggest that such business is totally riskless to the carrier.

Separate account business can subject the insurer to earnings volatility through fluctuations in fee income and policy mispricing. High agent commissions or policy bonuses, which are not appropriately priced for, can create negative financial results. These factors can also apply to general account business, of course. Insurers who conservatively price their contracts, maintain efficient operations, and who have achieved critical mass are better equipped to withstand the cyclical nature of market movements.

The current climate for insurers is difficult. It appears that special attention (mostly negative) is being paid by analysts to those with variable products exposure.

However, I tend to believe that few things are ever as rosy as they appear to be (see mid-1990s bull market), nor as bleak as they appear to be (see early 2000s bear market). Reality fits comfortably in between these polar attitudes.

This suggests to me that carriers with strong variable separate account skill sets, economies of scale, prudent risk management awareness, and deep distribution capabilities should still be appealing long-term players for sales reps, customers, and financial analysts to consider. This is especially true given the policy insulation protection that continues to be afforded by such products.

Timothy C. Pfeifer, FSA, MAAA, is a principal at

Milliman USA, a Chicago actuarial consulting firm. His e-mail address is

tim.pfeifer @milliman.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, October 7, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.