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Offers Details On New Stochastic Fitch Model

Fitch Ratings detailed its new stochastic model to analyze VA capital requirements and discussed the shift in how risks associated with variable annuities with guarantees are being handled by both regulators and companies during a teleconference on Aug. 4.

The size of the variable annuity market was estimated to be $1.1 trillion in assets in first quarter 2005, according to VARDS, a unit of Morningstar, Inc., Chicago.

The rating agency applauded the likely implementation of new capital requirements for VA s with guarantees that the National Association of Insurance Commissioners, Kansas City, Mo., could adopt at its fall meeting in New Orleans next month.

In June, the NAIC’s C-3, Phase II project was advanced by the NAIC’s Financial Conditions “E” Committee. It will be reviewed by the NAIC’s executive committee and possibly by the NAIC plenary before full adoption. If fully approved, the new requirements would take effect at year-end 2005.

A related reserving project using many elements of the C-3, Phase II project is also currently underway.

During a discussion on the changes underway and the Fitch stochastic model, Fitch analysts Jeff Mohrenweiser, Peter Patrino and Doug Meyer offered some of the following incites:

==by some industry estimates, there are over 600 product variations;

==the new Fitch model and the changes underway would result in no immediate downgrade of issuers of VA s with guarantees;

==increases in capital requirements are “manageable” because of the strong capitalization of these VA writers;

==Fitch will give credit to a company’s hedging programs based on factors such as the programs’ sophistication and length of time in operation;

==the range of programs Fitch is seeing varies from the very sophisticated to ones that use deep out of the money puts that are reviewed once or twice a year in a more static approach;

==greater awareness of the volatility of guarantees is causing some companies to raise prices while others are lowering prices;

==coming out of the bear market, some companies are introducing products that “eliminate certain adverse policyholder behavior” with new product features, and consequently, enable them to charge lower prices that are commensurate with risk.

==a balance between hedging and over hedging needs to be reached because over hedging can eliminate upside profit potential.

As explained by Patrino, the Fitch model looks at factors including the guarantee type, asset mix, the age of the business and the policyholders’ age. The new model can tie capital requirements to rating calibration points, he adds.

It also creates an more economic examination of a company’s risks, reflecting changes in the equities market rather than a linear static look, Patrino said.

‘An increase in capital requirements is manageable and no immediate downgrades are likely’

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