Variable annuity issuers should consider lapse rate risk as well as capital markets risks when designing and selling products, according to researchers at Oliver Wyman.

The researchers at Oliver Wyman, New York, a consulting arm of Marsh & McLennan Companies Inc. (NYSE: MMC), write about lapse rate risk and other behavioral risks in a new report.

A behavioral risk is the risk that policyholders will fail to handle policy ownership as product developers expect.

The VA industry “remains woefully underinvested in understanding, quantifying and communicating the behavioral dynamics of VA books,” the Oliver Wyman researchers warn.

In the case of lapse rates, they say, the specific risk is that “shock-lapse” assumptions built into VA guaranteed minimum death benefit features will not prove out.

For instance, a common assumption is that up to 50% of policyholders will lapse their VAs at the end of the surrender charge period. If a larger than expected percentage actually keep their policies, that would erode the capital position of many insurers, and those insurers would then have to post reserves and capital for VAs they had expected to lapse, the researchers say.

VA insurers can improve their behavior risk management through measures such as improving behavior modeling and forecasting capabilities, and integrating behavioral risks more fully into risk management protocols, the researchers conclude.

In addition, if the insurers can demonstrate improved understanding of “customer behavioral dispositions,” that could help spur a needed revival of the VA reinsurance market, they say.