Fitch Ratings is making an effort of its own to use “stochastic model” to analyze insurers in the $1.1 trillion U.S. variable annuity markets.[@@]

Users of a stochastic model start with a mathematic equation, or set of equations, that describes a particular product or market. The users then feed in data for hundreds, thousands or even more scenarios, to see how the product or market will perform under a wide range of conditions.

Fitch, New York, has come up with a model of its own that includes variables for factors such as the guarantee type, the asset mix, the age of the business and the policyholders’ age, Peter Patrino, a Fitch analyst, said today at a Fitch VA market teleconference.

The model also incorporates variables that reflect changes in the stock market, Patrino said.

The National Association of Insurance Commissioners, Kansas City, Mo., could adopt new capital requirements for VA contracts with guarantees in September, at its fall meeting in New Orleans.

The NAIC also is reviewing reserve requirements for universal life products with secondary guarantees.

Here are some other insights that Patrino and 2 other Fitch analysts, Jeff Mohrenweiser and Doug Meyer, offered during the VA market teleconference:

- The new Fitch model and the changes under way would result in no immediate downgrade of issuers of variable annuities with guarantees.

- Increases in capital requirements are “manageable” because of the strong capitalization of the 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 only once or twice a year.

- Greater awareness of the volatility of guarantees is causing some companies to raise prices even as other companies are lowering prices.

- Coming out of the bear market, some companies are finding ways to charge lower prices by introducing products that discourage holders from making frequent, rapid trades and engaging in other adverse behavior.

- Companies have to guard against hedging too much risk, because over-hedging can cut potential profits.