VAs: Still In Demand But They Need To Change
Many insurers today are reviewing their variable annuity portfolios and some have decided to exit the business altogether. Yet, market demand for VA products continues.
What then is the future of VAs? The question comes against a two-year backdrop of challenges. For instance, VA margins have declined as insurers grappled with: increasing costs of death benefits, income benefit issues, reduced fee income and lack of reinsurance for guarantees. In some cases, inadequate margins have left companies with significant losses.
In assessing the future, it is important to know that companies can make a profit on VAs, although not in their current form. The evolution of VAs over the last decade suggests the changes that need to be made. (See the chart for a quick overview.)
Along with the product innovations noted in the chart, variable insurance companies continued to add investment options to their product throughout the 1990s. They also increased commissions and to some extent provided better service to try to gain market share and distinguish themselves in a very competitive environment.
All these enhancements took place during a soaring stock market, with existing contracts generating greater than expected fee revenues. Companies wanted to increase market share to leverage expense structures and increase annual profits. To accomplish their goals, they increased commissions and/or added higher guarantees.
But many companies made the product changes without regard to the increasing equity exposure they were assuming with each enhancement. The added commissions increased the deferred acquisition cost (DAC) asset and surplus strain associated with new business. The guarantees could not be reinsured, and companies assumed the risk without robust analysis of the cost.
The additional investment options made it harder for such companies to understand and manage the equity risk they were assuming on the guarantees.
The pressure of increasing market share made it difficult to increase fees or reduce guarantees, especially since many viewed the probability of an equity market crash to be remote.
Nevertheless, the market did crash and companies are now left with unrecoverable DAC assets, high guarantee costs and reduced fee revenue.