Most variable annuity insurers believe there is no returning to the tax-deferred wrappers of over a decade ago. They believe demand for guarantees in the VA market is here to stay, and that the current market crisis has made the VA story of upside potential with downside protection even more powerful.
The challenge is to find an equilibrium that satisfies insurer, agent and customer.
The insurer has to be able to manage the risk associated with providing VA guarantees. Other things being equal, in turbulent times this means a significant increase in price for the guarantee.
That may be fine with customers who appreciate the value of the guarantee. But customers often have very short memories. When markets return to a more normal state, customers may not fully appreciate why the charge needs to be so “high.”
As for agents and distributors, they often do not have short memories. In turbulent times, insurers may have to pull products from the shelf until replacements can be developed, filed, and approved. That may leave agents with few or no product options, just when customers are demanding those options. This disruption in product supply clearly hampers business. It may take a long time before agents again trust the insurer.
How can VAs be made more sustainable so all parties involved can be comfortable with the product? Here are some ideas.
Setting expectations: The VA market generally features products with fees that are largely fixed for the life of the contract. Obviously, the account value depends on market performance, but the mortality and expense charge is generally fixed. The guaranteed living benefits traditionally feature a current charge and a guaranteed charge. In many cases, the current charge increases only if the customer elects to reset the guarantee (essentially restart it at the current account value).
In today’s market, expectations need to be set with both agent and customer regarding VA pricing factors.
For instance, the agent needs to expect that pricing for a particular rider will vary according to market environment. That won’t thrill agents, but it is much better than having nothing to sell. Customers need to be told to expect that the charge for the guarantee is going to vary yearly but it will never be greater than a guaranteed value.
Another approach is to use a higher charge, but set the expectation that “charge vacations” will occur in years when the cost to provide the guarantee is less than projected. Obviously, the product filing needs enough flexibility to allow for this.
Subaccount asset allocations: Most VAs with guaranteed living benefits sold today feature some type of restriction on asset allocations. Often this is a prescribed asset allocation model having a certain equity/bond allocation–e.g., a moderate aggressive portfolio with a 60%/40% equity/bond allocation. This might meet the customers’ risk tolerance in normal times, but not in a turbulent environment.
What if a moderate aggressive portfolio were instead described as a historic average return of 8% and a 10% probability of a 20% drop in one year? This portfolio would adjust the equity/bond percentages so that the 10% probability of a 20% drop in one year is maintained. In turbulent times, the allocation would move more towards bond, vice-versa in more normal times. This kind of dynamic allocation likely matches customer risk tolerance and enables the insurer to stabilize the cost of providing the guarantee.
Focus on asset fees: In a low interest rate environment such as today’s, high asset fees can make a generous guaranteed living benefit essentially unhedgeable. Asset fees, such as investment management fees, M&E charges, rider fees and slow account value growth make it more likely that the guarantee will be in-the-money.
Investment management fees can vary dramatically by asset class. Higher fees may or may not be valuable to a customer that is buying lifetime income with upside potential through a VA with a GLWB.
M&E fees generally vary by length and nature of surrender charge. An A-share policy with an upfront load rather than a surrender charge often has lower M&E charges than either a B- or L-share product. All else being equal, the same guarantee will cost less on an A-share product.
Rider charges have had to increase to cover hedge costs in this environment. Insurance companies need to be careful that these charges do not become so large that the benefits are made unhedgeable.
The above three approaches should help make the VA guarantees consumers are demanding more sustainable. If the insurance industry can respond to the demand with products that are manageable, sustainable and marketable, the industry can truly achieve wins for the consumer, agent and company.
Timothy E. Hill, FSA, MAAA, is a consulting actuary and principal with Milliman Inc. in the Chicago office. His e-mail address is email@example.com