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October 27, 2008 at 11:55 AM
Investment market turmoil could hurt the earnings and risk-based capital levels of variable annuity issuers well into 2009.
Analysts in the Chicago office of Fitch Ratings come to that conclusion in a discussion of the effects of recent financial turmoil on variable annuity risk.
Market drops may have put more VA guarantees “in the money,” and that could force insurers to back the guarantees with about $14 billion in additional capital, the analysts write.
“Fitch is concerned that insurers are overly optimistic about the effectiveness of their hedging programs, which have not been tested under prolonged adverse market conditions,” the analysts write. “The performance of these hedge programs will suffer as pricing assumptions did not forecast this elevated level.”
Insurers have been using “stochastic” statistical forecasting techniques to determine how VA programs might perform under a wide variety of conditions, the analysts write.
One challenge is that VA products probably will be profitable under 90% of the scenarios used, but 1% of the scenarios could generate large losses and capital needs, the analysts write.
If “in the moneyness” has increased 10%, then the need for capital may have increased 55%, or $14 billion, to 2.8% of total net asset value, the analysts estimate.
