One of the issues that nag at variable annuity advisors and distributors concerns the strength of the new guarantees, including living benefit guarantees, which are being positioned as critical to a client’s retirement income plan.
Specifically, will the guarantees perform as promised?
Now comes a research report from LOMA, Atlanta, that helps shed light on that question. Called Managing Guarantee Risk on Variable Annuities, an Introduction, it contains technical information geared for industry professionals who have been trying to understand the VA guarantee explosion.
Written by Jean C. Gora, manager of research and the Information Center at LOMA and reviewed by other LOMA experts and also several experts from the Society of Actuaries, Schaumburg, Ill., the 25-page document says 3 technical processes are needed to support VA guarantee management. These are stochastic modeling, financial engineering and hedging (see box below).
Further, the report says, to be successful in using these techniques, VA providers must have “significant” intellectual capital in their actuarial and investment departments and also “significant” systems resources, both of which are expensive.
Few insurance decision-makers outside of actuarial and investment departments are familiar with these concepts, LOMA says.
This lack of awareness is apparent, despite the fact that VA guarantees have become big business. (One trillion dollars in VA assets likely have some form of death benefit guarantee, and $500 billion of such assets may carry some form of living benefit guarantee, says the report, which extrapolated the data from the 2005 Annuity Fact Book, from National Association for Variable Annuities, Reston, Va. The report also says the independent distributors who now sell a lot of VAs believe they need the guarantees to make the sale.)
The lack of awareness is also evident despite the fact that VA guarantees present insurers with many risks (investment risk, interest-rate risk, etc), and customers with, as the report puts it, the need to know that their “VA funds will be available at withdrawal at levels specified under the guarantees.”
LOMA says it issued the report to fill the knowledge gap in this area.
Do people on the distribution side of the house need to know, too? That depends, says independent VA marketing consultant Harvey Hirsch, New York City.
Broker-dealers need to know “in spades” what makes for successful guarantees (and other VA features), Hirsch maintains. “The B-Ds are the gatekeepers. They need to be sure the products going through their systems (and offered to customers) are the right ones for the customers” and have been analyzed for strength and performance.
The B-Ds bear “gigantic risk” in performing this duty, both reputation and fiduciary risk, he continues. So they need to conduct independent due diligence on the products they offer. This must be ongoing, not once every 5 years, and it must be in detail. “They just can’t take some provider’s word for it, that the features (like guarantees) will stand the test of time,” he says.
The B-Ds should even be willing not to offer a hot new guarantee or other VA feature if they can’t understand it or be assured it is being properly managed, Hirsch adds.
What about the reps and other financial advisors? “They need to understand that due diligence on the guarantees and the product has been thoroughly done,” says Hirsch, “and they need to know that their B-D believes the products will stand the test of time.” The specifics of how particular issuing companies manage their guarantees could be interesting to a rep, but what is critical is for the rep to know that the B-D has examined this and other areas carefully, he indicates.
What do clients need to know about the guarantees and their management? “The wise client might well ask, ‘How do I know that this guarantee will perform as you say?’” says Hirsch. “If that happens, the rep is not going to talk about stochastic modeling, financial engineering and hedging. Instead, the rep will point to the rigorous due diligence done by the B-D, the rating of the insurance company that backs the guarantee, the brand of the company, and related factors.”
Often, if the issuing company is well known and highly regarded, and if the rep has established trust with the client, that will be enough to satisfy the customer, adds Hirsch. But if the company is not well known and highly regarded, the rep will have to work harder to address the concerns.
Even though the need to know varies by position on the distribution chain, Hirsch stresses that it is important for industry professionals to be informed in this area. Product features like guarantees are not things that clients think about until they need the money, he notes. So somebody else needs to do the thinking for them, to be sure the features are managed properly.
What’s important is not only that the money is available, but that it will be available when needed, he adds. “It is also important that the expenses for the guarantees are not so large that they nibble away at the growth in the contract.”