VA Guarantees May Be Hot, But For Reinsurers, Not
The word invariably used to describe guarantees in variable annuities is “hot,” as in very popular. But for reinsurers, the features are still, for the most part, a case of too hot to handle.
Reinsurers continue to look at potential business but are very cautious about taking on new business, interviews suggest.
Even with the stock market teasing investors with the promise of a rebound, for the moment the word on reinsuring VAs with guarantees continues to be “handle with care.”
With demand so high and supply so tight, in the long run, there probably will be new providers of reinsurance for these products, according to Ari Lindner, senior vice president and chief life officer with Ace Tempest Life Reinsurance LTD, Hamilton, Bermuda.
In fact, an unconfirmed report suggests that a startup reinsurance company will be offering reinsurance on VA guarantees.
Lindner says there are rumors of new entrants but offers a word of advice: “You cant do it halfway. Any company that did five or six deals in the late 1990s is not in a good place right now.” There has to be a strong understanding of the business, he continues.
The reason, he explains, is that with the proliferation of new benefit features, full attention needs to be given to the risks a reinsurer will be assuming.
For instance, Lindner says that while the VA with a guaranteed minimum withdrawal benefit is the “hot product” in the market, it is also one he believes “is not priced or structured appropriately.”
This is because there needs to be strong performance in the first couple of years of the contract, he explains. If the market performs poorly in the first couple of years of the contract, it doesnt matter if performance improves later in the contract because money that should have been accruing will not be there to support the benefit.
Lindner explains that for reinsurers, the return on capital is too low. Direct writers can make money on other components of the product such as the mortality and expense component of the contract.
But for the reinsurer, “we only make money on the rider and a 5% return on capital is not going to cut it,” he adds.
Ace Tempest is looking at GMWBs, according to Lindner, but “at this point, we are so far apart on price and structure that I dont think there is a good chance [the company would reinsure that risk].”
Additionally, there is a tension between pricing properly and competing effectively. For instance, he said, a company could not charge 1.25% for a GMWB feature when everyone else is charging .35%.
Most of the guarantee benefits his company is looking at are guaranteed minimum death benefits, earnings enhancement benefits and guaranteed minimum income benefits, he says.
“We are very picky” in reinsuring guaranteed minimum accumulation benefits, Lindner adds. “We want to see a fairly significant asset allocation restriction.”
Additionally, there needs to be a fixed account requirement as opposed to fixed income funds, and 30%-50% of money should be in these fixed accounts, he continues.
The reason, according to Lindner, is that the earnings on the fixed account component of the contract offsets the point at which money would have to be put up if there is a drop on the other part of the contract.
And on the issue of offsetting benefits, if capital efficiency is created, then a price efficiency is created, he says.
Pricing and the structure of a product will be important going forward, says Jim McArdle, vice president of structured solutions with Transamerica Reinsurance, Charlotte, N.C.
Transamerica is not accepting GMDB or GMIB business, he says. The reason, McArdle explains is that when the product structures and fees were examined, it was determined that benefits were rich compared to the prices being charged to contract holders.
However, newer benefits such as accumulation and withdrawal benefits have a better risk profile, according to McArdle. For instance, withdrawals under WB contracts are taken over an extended period of time.
And while some companies are selling lower risk benefits, other companies are using hedging strategies.
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.