VA Guarantees May Be 'Hot,' But For Reinsurers, Not

Tim Pfeifer, a principal with Milliman USA, Chicago, also believes that even if the equity market is showing signs of reviving, “in reality, the [VA reinsurance] market is still dry.”

So, what many direct writers are considering, he says, is either hedging strategies or offering products with benefits that complement each other in terms of risk.

Hedging needs to be done dynamically with the regular purchase of futures options, since exact hedging of risk through these options does not usually occur, Pfeifer continues.

And, even those companies that currently are doing dynamic hedging probably still need to work on it, he adds.

Complementary benefits with offsetting risks, he says, might, for instance, be a GMDB packaged with an earnings enhancement benefit.

Reinsurers, like direct writers, like to spread risk, Pfeifer says. Spreading risk is important, he continues, because “these benefits create a concentrated risk. When you give people the option to use them, they will.”

But some of the benefits being offered make it difficult to assess risk, he explains. The elective utilization rates of certain guaranteed benefits such as the guaranteed minimum income benefit and the guaranteed minimum withdrawal benefit are not easy to determine, Pfeifer adds. The GMWB can also require a large amount of capital, he notes.

However, a feature of the withdrawal benefit that could hold more appeal to reinsurers is that the payout is over time, Pfeifer adds.

If withdrawals are made over time, then markets can move up and down, and the account can still have enough to cover the withdrawals because the benefit does not become due on one effective date, he says.

In addition to the different risks associated with these benefits, Pfeifer says new risk-based capital requirements being developed could increase the cost of pricing these benefits (see related story on page 35).

One thing Pfeifer maintains with a degree of certainty is that companies will not stop offering guarantees. “It wont happen.”

The response to the current market may be the entrance of additional reinsurers or increases in the prices consumers pay for these guarantees, according to Pfeifer. To some extent, prices are beginning to increase, he continues, adding that asset allocation requirements may also be put in place.

The GMIB is probably harder to hedge because of the difficulty in determining the election rate, according to Scott Robinson, vice president and senior analyst with Moodys Investors Service, New York. From a ratings perspective, he says, Moodys looks at how material that block of business is to a company, if it is selling a lot more than the rest of the industry, and, if so, why.

The reason guarantees will continue to be offered, according to interviews, is simple: Consumers want them.

During a Standard & Poors conference last month, Richard Vaughan, executive vice president and chief financial officer with Lincoln Financial Group, Philadelphia, said that although his company does not offer many guarantees in its variable products, it has offered some GMDB features and has just introduced a GMWB feature.

The reason for rolling out a GMWB, he said, is simple: “It is the hot product in the marketplace today.”

Lincoln National decided not to use reinsurance but rather, does its own hedging, he continued. The reason, according to Vaughan, is that reinsurers also hedge to offset risk, so using reinsurance would be layering one hedging cost over another.

But, he noted, in the case of Lincoln, “we are a scale player,” so it can be done at a cost-effective price. It is a predictable risk that can be priced well, Vaughan adds.

Lincoln has chosen to reserve for its GMDBs rather than reinsure them, he said.

Reinsurance is hard to come by and when it is available, what is covered as well as cost is an issue, according to Eric Henderson, associate vice president and VA product manager with Nationwide Financial Services, Columbus, Ohio.

Reinsurance that is available does not cover 100% of the risk so direct writers can still be responsible for sizeable amounts of money if consumers use guarantees in their contracts.

A company can choose to hedge its own risks, an option Nationwide has undertaken, he says. The company began exploring hedging with a pilot using a small part of its business before it dedicated staff to that function, Henderson says.

Other options companies may consider include raising the cost of the benefit or changing the benefit, he adds.

The use of hedging has made it possible to continue to offer guarantees such as a new living benefit with a capital preservation feature, Henderson says.

Reproduced from National Underwriter Edition, July 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.