This is the second of a series of articles that will be published on the annuity space.
Since the financial crisis of 2008-09, many insurers have rethought their strategy around the variable annuity (VA) market, with some players exiting the space, others exercising caution in continuing to offer generous benefits, and a few recommitting in terms of sales and consolidating their leadership positions. Insurers that opted to stay in the market changed their pricing, product designs and risk management approaches as a means to “de-risk” their VA businesses in the face of historically low interest rates and sometimes volatile equity markets and FX rates.
While the impacts of these risk mitigation moves–including the use of target volatility funds–have been met with some success, VA products still contain residual risk, which must continually be addressed in the low interest rate environment. Additionally, insurers seeking to sell VA business with attractive risk-adjusted returns must carefully weigh the impacts of their risk mitigation approaches on other parts of their business, model newer products (such as target volatility funds) accurately and refine their product offerings appropriately.
Today, the top three writers of variable annuity products capture more than 45 percent of total premiums,a major shift in a market that was much more fragmented just a few years ago. The companies that exited the market have done so for a variety of reasons, including risk-reward trade-offs and concerns about the volatility of the business on their GAAP and statutory financial statements.
The companies that stayed in the VA market saw an opportunity to seize market share and generate more VA revenue either now or as market conditions improved over time. However, these companies are generally moderating their guarantees and also recognizing the need to strengthen their risk management activities. Thus, they are proceeding with added caution.
It will be interesting to see whether new entrants emerge to assume risks on legacy blocks of business or offer product solutions in the large and growing retirement income market.
Changing living benefits riders
The living benefit (LB) rider landscape continues to change. The number of closed and modified LBs significantly outweighs the number of new LBs, according to research from the Ernst & Young’s Retirement Income Knowledge Bank. To date, the primary de-risking mechanism has been to increase fees, while the inclusion of target volatility funds in separate account portfolios has replaced investment option restrictions and benefit reductions as secondary de-risking mechanisms.
More recent products have also included auto-rebalancing features, based on constant proportion portfolio insurance (CPPI) algorithms, which drive dynamic asset allocation within individual volatility funds and across asset classes. CPPI algorithms were also designed as a way to de-risk VA products. Companies have continued to refine their algorithms; for instance, CPPI algorithms did not initially allow policyholders to materially participate in rising markets–a deficiency in the first generation algorithm fixed in more recent generations.
Volatility-managed funds (often referred to as target volatility funds) were introduced in 2010 and are typically based on proprietary strategies; different asset managers apply their own “secret sauce” for reducing fund volatility, given their view of market trends. Given the proprietary nature of the “secret sauce,” there is no such thing as a generic volatility-managed fund.