Don't Lose Sight Of A Key VA Aspect

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

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.