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Hedging Has Helped Variable Annuities: Moody's

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Most variable annuity writers’ hedging programs have worked well in spite of recent market volatility, Moody’s Investors Service says.

In a new report, Moody’s observes that life insurance carriers have reported increasing GAAP liabilities on guarantees for VA contracts due to declining equity markets and interest rates.

“However, gains recorded on hedges entered into by variable annuity writers to reduce the risks assumed by making these guarantees have largely offset the increased GAAP liabilities,” according to the report, “Variable Annuity Writers’ Hedging Programs Tested by Market Turmoil.”

“The secondary effects of increased capital market volatility may be more significant to insurers’ financial results on these products over the long term,” says Moody’s vice president Arthur Fliegelman, one of the report’s authors.

Fliegelman believes that if higher market volatility persists, carriers’ long-run product hedging costs, resulting in lower product profitability.

“Offsetting the increasing hedging cost is the greater attractiveness of products offering guarantees to consumers during periods of increasing levels of market uncertainty,” he observes.

Moody vice president Wallace Enman, the other author of the report, pointed out that the recent adoption of the Statement of Financial Accounting Standards No. 157, covering fair value measurements, has caused many insurers to record additional GAAP charges.

The new standard requires that several factors be applied in valuing embedded guarantees of VAs, some of which might not have been used previously by a number of companies. These include an adjustment for the risk of an insurer’s nonperformance.

“The impact of adoption of the accounting standard does not represent a change in the economic standing of the variable annuity writers, and therefore it is unlikely to affect Moody’s assessment of most insurers’ financial strength,” Enman says. “In particular, the adjustment for an insurer’s nonperformance risk does not affect the intrinsic liability of a VA writer.”