The Dodd-Frank Wall Street Reform and Consumer Protection Act could increase the cost of the derivatives that insurers use in annuity programs, an executive says.

The topic came up during a second-quarter earnings teleconference focusing on Prudential Financial Inc., Newark, N.J. (NYSE:PRU). Prudential reported $1.1 billion in total net income for the quarter on $11 billion in revenue, up from $163 million in net income on $6.9 billion in revenue for the second quarter of 2009.

During the call, a securities analyst asked Prudential executives for their thoughts about how the Dodd-Frank Act might affect Prudential’s hedging costs and variable annuities.

Mark Grier, executive vice president of financial management at Prudential, said uncertainty remains.

“While the passage and signing of the bill represented a climax to the whole process of fixing everything, there’s a lot of work to do in terms of interpretation, writing rules and implementation,” Grier said.

Grier said Dodd-Frank could cause have more than one type of effect on annuity operations.

“I would anticipate that the providers of the long dated equity-linked derivatives that we use in our annuity business may be required to hold more capital,” Grier said. “As a result of that, we may see a more expensive environment in which to use

those derivative products. However, on the other side of it, the combination of clearing and possibly exchange rating with respect to a lot of other kinds of derivatives we use, particularly the more plain interest rate derivatives, may drive the cost of those derivatives down somewhat.”

Other insurers have started to talk about the possible effects of the Dodd-Frank derivatives provisions in their second-quarter 10-Q financial reports.

Hartford Financial Services Group Inc., Hartford (NYSE:HIG), says it believes the new derivatives clearing, margin and capitalization rules will increase the cost of its hedging program.

MetLife Inc., New York (NYSE:MET), says the new derivatives requirements could reduce its liquidity and increase the cost of the derivatives it uses to protect itself against the risk associated with annuity guarantees. If the new rules limit MetLife’s ability to customize derivatives, that could also cause problems, the company says.

VARIABLE ANNUITIES

During the earnings call, Prudential executives also talked about the rebound in the variable annuity (VA) market.

Prudential says its VA sales increased to $5.3 billion in the second quarter, up 57% from the total for the comparable quarter in 2009.

“It’s hard for us to predict where the momentum stops,” said Bernard Winograd, chief operating officer of Prudential’s U.S. operations. “

Prudential is not seeing competition for its Highest Daily strategy, Winograd said.

Some people may be working on products that would enable them to imitate or compete more directly with the HD format, but building the systems to support that approach will take a great deal of time and resources, Winograd said.

Much of the VA growth is coming from the opening of new distribution relationships that are selling more than existing distribution relationships, Winograd added.

“We haven’t annualized fully the impact on the business system of all that new distribution,” he said.

However, at some point, he said, “people will respond in ways that we won’t choose to or be able to compete with and the market share will level off. Where that is, is very hard for us to estimate.”

“Business is moving around, players have exited or reduced their level of aggressiveness in the market, and new players are entering,” Grier said. “So, part of this is that there is just a big shakeup, and I’m not sure how long this will continue.”