VA Guarantees Feel Reinsurance Squeeze
An optimist might say theres both good news and bad news for variable annuity writers who want reinsurance for some of the guarantees in their products.
The good news is that insurers who sell VAs with guarantees–including income, living and death benefits–will still be able to get reinsurance to support those features.
But the bad news is that its going to cost plenty, and there will only be a limited amount of it available.
“There is always someone [to provide reinsurance] but at a price,” David Greenfield, a partner with KPMG LLP, New York, says of the reinsurance market for variable products with guarantees.
Bermuda is a relatively small market but one with a fair amount of capital, Greenfield says. However, he notes, the challenge that direct writers have is to create a product reinsurers feel more comfortable with.
Ace Tempest Life Reinsurance LTD is one of the reinsurers that continues to reinsure guarantees on VAs, says Ari Lindner, senior vice president and chief life officer with the company based in Hamilton, Bermuda.
But reinsuring those risks “is complicated. There are a lot of different moving parts,” Lindner adds.
A lot of assumptions are made before these contracts are reinsured, he continues. Some of these assumptions include mortality and lapse rates, demographics and the average size of a policy.
Lindner has been working with VA guarantees since 1996 and has seen the demand for reinsurance come full cycle.
In the mid- to late-1990s, prices were low because it was easier to figure out what the risk was worth, he says.
Many direct writers decided in 1999-2000 that the risk was low enough to stop using reinsurance and even to begin recapturing business they had already reinsured, Lindner recounts. They felt, he says, they were paying for protection they would not need.
But the stock market peaked in March 2000 and by early to mid-2002, many companies were once again looking for reinsurance, Lindner says.
However, what they found, depending on the benefit they were offering, were prices that in some cases had doubled, he says. In fact, Lindner continues, in some cases prices had a lot more than doubled, with increases approaching 10 times what rates were a few years before.
There is no specific rule of thumb on the pricing of these benefits, he says, although, in general, the cost depends on the structure of the reinsurance agreement and the benefit offered. Generally speaking, living benefits do cost more, but, again, it depends on how the benefit is structured, Lindner says. There are times when guaranteed living benefits can cost less to reinsure than death benefits, he adds.
So, the direct writers profitability on the guarantee may depend on how much margin is built into the base mortality and expense charges in the product, he explains.
Or, a direct writer may need to consider a deductible before the reinsurance agreement becomes effective, Lindner adds.
Because of the changes in the availability and cost of reinsurance, guarantees are changing, he says. Companies are spending more time and resources to analyze the risk and thus, the real worth in guarantees, according to Lindner. A lot of these guarantees are like options and in a volatile equity market, they can be hard to price, he continues.
Some products and guarantees have been poorly designed in the past, but big VA carriers cannot afford to have a poorly designed product and will spend more to examine product design and cost, Lindner says.
In some cases, these benefits may be treated as optional rather than base benefits in an annuity contract, he adds. In other cases, rollup rates may be reduced to 5% from 6%, Lindner continues.
Direct writers may also raise the retail cost of the product, Lindner says.
Right now, he says the landscape is just beginning to shift, and it will probably take another year before this becomes more evident.
Several insurers contacted by National Underwriter declined to provide comment for this story.
However, Prudential Financial, Newark, N.J., says it self-insures any risk from guarantees in variable products.
Reinsurance plays a key role in mitigating risk and managing capital for both the company and for product lines, including variable annuities, according to Tim Benedict, a spokesperson at GE Financial Assurance, Richmond, Va. However, “product features and design are primarily driven by the issuer in response to consumer needs,” Benedict adds.
More broadly, he says, “We are seeing the issuing market changing as insurance companies review these types of features. The reinsurance market is also changing, de-emphasizing reinsurance for these kinds of benefits.”
But again, Benedict notes the importance of product development as a response to consumer need and not what reinsurance is available.
“If you turn the clock back five to six years before the problematic equity market,” reinsurers were willing to write business, says Tim Pfeifer, a principal with Milliman USA in Chicago.
But two to three years ago, reinsurers became “uncomfortable with the level of equity risk” and left the market.
Indeed, in January, AXA Group announced it would be revamping its reinsurance operations and largely leave the U.S. life reinsurance market. AXA was a big reinsurer of VA guarantees.
The announcement followed decisions by the likes of Swiss Re, which stopped writing these risks at the end of 1998, and CIGNA, which left the reinsurance business.
But Pfeifer says he believes the dearth of reinsurance will not cause guarantees to dry up. “Thats the big question. My own opinion is that it wont.”
While the demand for guarantees will remain, Pfeifer says he doesnt “see a lot of reinsurers re-entering the market on this one.”
There are several reasons for this belief, he says. Gauging the equities market is difficult, so you really cant charge enough for the guarantees, he continues.
Also, companies will potentially have higher reserving requirements and risk-based capital standards because of recent regulatory projects, Pfeifer explains.
Those requirements will be affected by Actuarial Guideline MMMM: Reserves for Variable Annuities with Guaranteed Living Benefits and the Life Risk-based Capital Phase II project that would establish risk-based capital requirements for products with guarantees.
Guideline Quad-M, a temporary guideline developed until a more permanent one paralleling the Phase II project can be developed, addresses guaranteed living benefits for VAs. An asset adequacy test is used as a key piece in a valuation actuarys determination of what proper reserves should be for the guarantee.
Currently, death benefit guarantees are not specifically addressed by RBC requirements, according to the National Association of Insurance Commissioners, Kansas City, Mo.
However, the NAIC says, products with guarantees in general would receive an RBC charge and would get a different charge than those products without guarantees.
And, if the Phase II project is ultimately adopted by the NAIC this year or in 2004, then RBC requirements would be determined after an actuary performed numerous scenarios for assets and liabilities to determine proper capital requirements, says Alastair Longley-Cook, chair of the project being developed by the American Academy of Actuaries, Washington.
Without ready, inexpensive access to reinsurance, direct writers will reconsider the way they offer guarantees to meet both market and regulatory conditions, Pfeifer says. For instance, a customer may only get a guarantee if there is a certain type of asset allocation such as a focus on fixed income funds and general account options, he adds. Customers would not have to necessarily put a lot of money in those options, he continues.
Another strategy employed by direct writers will be to develop hedging programs to cover long-tailed risks if the market drops, Pfeifer says.
Those reinsurers that are able to continue offering reinsurance can do so because of resources and systems in place that make it possible to analyze risks and set up hedging programs, says Clifford Angstman, principal, Lighthouse Financial Consulting, Charlotte, N.C.
Having the right systems in place can help prevent underpricing of reinsurance, he continues.
Reproduced from National Underwriter Edition, February 17, 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.