As the economic recovery continues, it remains to be seen whether all of the variable annuity writers emerging from the recession will still be around in a few years’ time. That’s because many are struggling to cope with some creative (and perhaps toxic) assets on their balance sheets: overgenerous guaranteed living benefit riders.
A Moody Assessment
According to a new survey of the 20 largest variable annuity writers by Moody’s Investors Service Inc., New York, the guarantees offered by the VA manufacturers in previous years remain a threat to their company’s capital positions, despite the release of new, less credit risky products.
The VA writers’ finances would be in a healthier state today if U.S. regulators had had oversight of the companies’ offshore subsidiaries. A little known fact is that some of the largest VA players artificially enhanced their capital positions by shifting risk connected with the products’ GLBs to these “captive” organizations, many of which are situated in less regulated countries, such as Bermuda. Collectively, the offshore firms are undercapitalized by up to $10 billion.
Upshot: the captives’ “onshore” (U.S.-domiciled) manufacturers can withstand at best a 30% drop in the equity markets, observes Moody’s. If the insurers experience greater losses as a result of declines in equity values, then the companies will likely take “significant hits” to regulatory capital levels.
To offset the cost of policy guarantees, Moody’s notes, the VA writers will need to revamp their hedging strategies (techniques used to mitigate investment risk) which in some cases have failed to keep pace with the rising values of the guarantees, particularly the popular guaranteed minimum benefit and guaranteed minimum withdrawal benefit riders.
More visible to consumers today are the less generous guarantees that VA writers have implemented since the recession to strengthen their balance sheets. Annual bonuses have dropped from highs of 7% of an initial investment only two years ago to less than 5% today.
Likewise, insurers have cut back on the guarantees while boosting the charges clients pay to secure them. GLB fees have crept up an average of 15 to 20 basis points–and in some cases 50 basis point or more–on many VA products.