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.
What will this mean for new products developed in 2003 and beyond? Companies will want to re-focus on the reasons VAs became popular in the first place–tax deferral plus the ease of transferring funds within investment options.
Guarantees will still play an important role. However, VA insurers will need to develop better modeling tools to determine the risk and cost of their guarantees. This is especially so, since regulators are reviewing new capital requirements for separate account guarantees.
Furthermore, companies will need to develop methods to limit the guarantee risk without complicated, expensive and usually ineffective hedging strategies. And the increased cost of the guarantees will need to pass to the consumer.
Consequently, some consumers will not want to pay for the guarantees. They will opt for a basic annuity form.
In this environment, companies will need a flexible product chassis that allows them to write multiple contract types with different fee structures and guarantees. This will allow brokers to present one product to the client. It will free them from having to make multiple sales pitches or carry additional marketing materials on each sales call.
Also, companies will want to focus on service, providing better marketing material, account statements, telephone support, licensing and problem resolution.
Currently, many companies are reviewing their VA product portfolio in light of the risks highlighted during 2001 and 2002.
The outcome of these reviews could mean reduced guarantees, stricter policy language, less exotic investment options and higher fees for consumers. It will also lead to product innovation, with the company that is able to design a product with some level of guarantees at a reasonable price coming out on top.
, FSA, MAAA, is a consulting actuary with Actuarial Strategies Inc., Bloomfield, Conn. You can e-mail him at [email protected]
Reproduced from National Underwriter Edition, February 3, 2003. Copyright 2003 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.