By Timothy C. Pfeifer
Industry observers have noted that A-share variable annuities are emerging as a topic of more serious discussion within the business lately. This is due to a number of recent market developments.
An A-share variable annuity, generally, is a VA characterized by a front-end premium load (i.e., a percentage of premium charge) and no surrender charge at the time of policy termination. Such policies can be viewed as by-products of similar designs found in the mutual fund marketplace.
The level of the front-end load in the A-share VA is typically at, or slightly below, the sales compensation and marketing expenses associated with the policy. This premium load percentage often declines as the amount of premium paid increases. For a flexible premium VA, an A-share version would charge the premium load at time of any subsequent premium payment.
A-share VAs tend to have other elements that are similar to those found in B- or C-share VAs. Since the A-share products charge an upfront premium load, though, the other policy charges, such as ongoing mortality and expense charges, are typically lower in the A-share VA than in comparable B-share VAs. A number of analyses have been produced which show that, over a long-term period, A-share products perform better than B-share product designs.
To date, A-share VAs have represented a very small percentage of total VA sales in the United States. For example, in the years 2001 and 2002, A-shares accounted for 1.2% of total VA sales, while the comparable figure in the year 2000 was less than 1%.
Reasons for the lack of A-share volume have typically centered on policyholder negativity toward immediate premium deductions, sales rep concern over the perceived linkage of the load to their sales compensation and the difficulty in using A-share products in bonus or 1035 situations.
Design challenges in defining guaranteed living and death benefits for A-share VAs also have been mentioned. In fact, the A-share product landscape today is dominated by a small number of distributors who account for a high percentage of sales.
Despite the points mentioned above, A-share VAs have been generating increased insurer discussion and product design interest, if not actual sales.
One reason for this is the fact that A-share designs can lessen the GAAP accounting risks that have plagued variable insurers of late. On B-share contracts, upfront costs are usually deferred and amortized for GAAP accounting purposes over a defined period of time based upon projected future profits.
To the extent that actual fund performance is lower than projected in the GAAP amortization schedule, or if actual terminations are higher than projected, a carrier may be forced to write off the unamortized deferred acquisition costs more rapidly than anticipated. This would lead to lower GAAP earnings or losses. For an A-share product, this is less of an issue, since the upfront costs are largely balanced by an upfront policy charge.
Another reason for the heightened interest in A-share VAs is the favorable policy performance for those policyholders who remain with the policy for a long period of time. This phenomenon is a function of the fact that most B-share products are designed so early terminations are at least partly subsidized by remaining policyholders.
Opportunities exist for creative and competitive VA designs built on an A-share platform. The biggest challenge will revolve around the willingness of distribution forces and customers to accept the notion of an initial premium haircut.
The A-share concept already exists in the immediate annuity product, although the nature of that product and the ways its loads are applied make it less obvious to the policyholder and sales rep.
Limited pay variable life contracts could also consider the A-share design, presumably with the same potential for improved long-term performance that VAs have.
Perhaps the time has come for A-share products to emerge more heavily as one of the viable VA product design options of the future.
Timothy C. Pfeifer, FSA, MAAA, is a principal in the Chicago office of the Milliman USA actuarial consulting firm. His e-mail is [email protected].
Reproduced from National Underwriter Edition, April 7, 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.