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Policyholders Getting Smarter, Leading to Charges for VA Products, Says Moody's

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Charges related to changes in policyholder assumptions on variable annuities with guaranteed benefits may emerge among life insurance companies in the U.S., putting a dent in earnings and capital, according to a new Moody’s report in the wake of ING’s announcement that it would take a 4th-quarter charge to earnings.

The Dutch ING Group just took a $1.1 billion charge for changes in policyholder “behavior” assumptions related to the closed block of VA policies in its U.S. operation. And these assumptions could hold sway at other insurers as well, according to the report by Laura Bazer of Moody’s. 

She said that, while assumptions charges are common, the specific ING charge could be part of a trend, as policyholders are becoming more informed about their complex insurance policies, and are acting to gain the value of guaranteed insurance benefits when they are “in the money.”

In pricing and hedging the risks of their VA contracts, companies must also make assumptions about how many customers will hold on to their policies long enough to be eligible for benefit, how many of them will exercise guaranteed benefit options when they become available and how many more of them may exercise those options, the report explains.

If the company’s assumptions underestimate how aware customers are in timing and making these decisions, “there can be significant unexpected additional economic costs to the company,” Bazer stated.

With ING, VA policyholders were found to be holding on to their policies longer, and in greater numbers than ING originally assumed. ING had to increase its reserves to reflect the larger number of policyholders that may ultimately receive benefits over the life of their contracts.

Moody’s noted that the Netherlands-based ING is not alone in taking charges for policyholders behaving differently than the insurer expected. Moody’s adds that each country has its own rules about setting reserves.

Canadian companies accounting and reserving methodologies may require greater and earlier disclosure of these charges, Bazer says, pointing out that  in the third-quarter 2011, Manulife Financial took an after-tax charge of CAD $309 million for changes to its assumptions for VA lapsation  and other policyholder behavior, largely at its U.S. John Hancock operation.

Similarly, Canadian insurer Sun Life Financial took a hefty after-tax charge for lapsation and other behavior assumption changes, also for its US operations.  SunLife announced today it was exiting the U.S. variable annuity market.

Sun Life stated in a release,  that it “will close its domestic U.S. variable annuity and individual life products to new sales effective December 30, 2011. The decision to discontinue sales in these two lines of business is based on unfavorable product economics which, due to ongoing shifts in capital markets and regulatory requirements, no longer enhance shareholder value.”

It also mentioned a need to reduce volatility. The estimated one-time transition cost associated with the discontinuation of these products is approximately $75 to $100 million on a pre-tax basis, a portion of which will be recorded in the fourth quarter of 2011, with the remainder expected to be charged to income in 2012.

U.S. players such as Prudential Financial have also taken charges in recent quarters, even if they are less visible to investors, Moody’s said. An email to comment from Prudential was not returned by press-time. 

“Lincoln National as well as the others –he referred to Hartford Life and AIG as other sellers of VAs with guaranteed benefits–  have done an adequate job of reserving but I remain somewhat concerned that the returns for this product in general may or may not be adequate,” said life insurance analyst Andrew Kligerman of UBS AG.

If companies fully hedge the assumptions for these products, the returns are anywhere between 0% and 5%, he said, noting that today, volatility and interest rate hedging costs are different than what they would be in more historic scenarios. While the trade group for life insurers declined to comment, the issue is on the radar of U.S. companies, and soome hold that there may be over, not under,- reserving on the U.S. side for these products.

U.S. statutory reserves for variable annuities are based  on Actuarial Guideline 43, and there might be different issues there with reserves at companies than with their Canadian counterparts, though. 

MetLife’s CEO Steve Kandarian stated on a third-quarter conference call that it would continue to make adjustments in some of its guaranteed benefit products.

“While we are comfortable with the pricing and returns on our third-quarter  VA sales, we continue to seek opportunities to reprice and improve  the risk profile of our product offerings. As of January, the rollup rate on  our  GMIB Max product will be reduced from 5.5% to 5%. We are closely monitoring sales and if they rise above plan, there are steps we can take and will take to bring sales in line. … As a matter of sound capital management, we will only pursue growth that we believe maximizes long-term shareholder value,” Kandarian stated on the 3Q call.



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