Variable Products: Who Is Bearing The Risk Now?

Like many other people, I have retirement assets invested in the equity markets. Thus, it has been a welcome change recently to see more up days than down days for the major indices.

Consumers have noted this as well. According to the Federal Reserve Bank of Boston, net mutual fund flows in May 2003 were negative for money market funds (-$17.8 billion) while other fund types (equity, bond and hybrid) were positive ($24.2 billion). Equity mutual fund net flows were $12.1 billion in May after enjoying $16.1 billion in net flows in April.

Although 2nd quarter statistics outlining interest in variable annuity separate accounts were not available at this writing, early indications suggest there has been a similar resurgence in equity investment in these products. This follows a lengthy period where deposits into fixed annuities and fixed accounts in VAs were in the lead.

Does this mean the giddy bull market days are returning, comparable to the days leading up to the spring of 2000?

Not so fast. A few things have changed, at least in the minds of a few VA players. A quick look around the industry reveals some companies are now missing from the VA market. Some decided that continuing VA sales is no longer in their business plan.

Other players have significantly restructured products, especially in the area of VA guarantees. VA guarantee benefits are not as rich today as they were even last year. Rollup percentages, for instance, are rarely in the 6%-7% range. Those products are being replaced by ones with percentages more like 4%-5%.

Some companies no longer offer certain guarantees, at all. And the guarantees that do remain now cost the consumer more than before (i.e., through increased mortality and expense risk charges).

So, what has happened? For one thing, requirements are forthcoming that will force companies to put up more reserves and capital to support VA guarantees.

Companies are also rethinking their risk exposure, especially in light of the severe equity market declines experienced from the spring of 2000 to the early part of this year.

It is old news that declining policyowner account value balances mean declining company M&E revenue in a falling market. What is now being discussed is the likelihood of never-before-seen drops in the market. Many VA guarantees (such as guaranteed minimum death benefits, guaranteed minimum income benefits, etc.) have a positive payoff for the consumer in a severely down market. This means the company potentially has a negative payoff in such market doldrums.

What does all this mean for producers and consumers? Is there a fundamentally different market environment out there, or are the market players more closely gauging all the possibilities inherent in VA benefits?

In the past, the rule for a financial advisor was to, in part, measure a clients appetite for the equity markets by the length of the expected investment horizon. Ten years was considered a pretty good bet for putting a portion of capital in equities. Conventional wisdom said 20 or 30 years was nearly a sure thing.

Does that still hold? Based on the changes seen in the VA market, it appears that some companies believe these horizons are riskier than previously thought.

This poses the question, who should have the greater risk tolerance: an insurance company or an individual?

It could be argued that, with its larger asset base and varied lines of business, the insurance company should have a greater risk tolerance. (Unfortunately, in the era of needing to meet quarterly earnings expectations, stock companies dont have the luxury of accepting too much fluctuation in the bottom line.)

As for individuals, it is true that they can diversify. However, substantial loss in even a portion of a persons invested assets could spell doom for the persons retirement plans.

It will be interesting to see how all this plays out going forward. Will individuals hold relatively less equity than late in the great bull run of the 1990s? It seems likely. However, this probably will not pose a problem for variable products, as both VAs and variable life policies provide a wide variety of investment options and risk profiles.

Even so, it would seem that advising clients about appropriate equity exposure has become more complex. Then again, perhaps nothing has really changed at all, aside from the fact that were all seeing reality a bit better.

Robert P. Stone, FSA, MAAA, is assistant vice president and associate actuary with American United Life Insurance Company, Indianapolis. His e-mail address is Rob_P_Stone@aul.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, August 11, 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.