When a life insurer issues a fixed indexed annuity with a minimum withdrawal benefit (GWMB) rider, the purchaser may sleep soundly at night, but the issuer has to think about...
5. Stock Prices Falling. Lower stock prices can hurt the issuer's fee revenue and put any benefits guarantees "in the money" — but Sarfatti classifies this as a lower-level risk, because issuers can usually hedge against this risk.
4. Stock Prices Soaring. Higher stock prices can hurt, too — by pushing up the amount of account value an issuer is guaranteeing. But Sarfatti classifies this problem as a lower-level risk, because issuers can usually hedge against the headaches created by rising stock prices.
3. Interest Rates Falling. When the bonds backing a guarantee have a shorter duration than the guarantee, an issuer may end up with replacement bonds that earn less than the desired yield. For insurers withe benefits guarantee riders, this is a medium-level risk, Sarfatti says.
4. Interest Rates Rising. If interest rates rise too much, and too quickly, annuity holders may let their contracts lapse. Sarfatti classifies this as a medium-level risk for the issuers.


5. Bond Downgrades and Defaults. Life insurers invest mainly in very high quality bonds that are unlikely to go bad, but, if a large percentage of the bonds in a portfolio backing an annuity benefits guarantee do go bad, that can cause headaches for the issuer, Sarfatti said. He classifies this as a severe risk.

Life insurance company risk managers spend their nights tossing and turning so their annuity holders can sleep soundly.

Aaron Sarfatti, head of strategy for life, retirement and wealth at AXA Equitable, talked about some of the risks facing issuers of variable annuities, indexed annuities and other products recently at the Insurance Summit, an event that took place in Kansas City, Missouri.

(Related: 3 Ways U.S. Households’ Life and Annuity Use Looks Weird)

The National Association of Insurance Commissioners, a group for insurance regulators, organized the event to give state insurance regulators, insurance company executives, consumer advocates, startup organizers and others a chance to learn, and talk.

Some of the sessions, for example, focused on matters such as investigating problems with an insurer’s internal controls, and how to keep an insurance company’s secrets secret.

Sarfatti gave the attendees a primer on how life and annuity products work.

He talked at length about how variable annuity contracts work, the kinds of risks VA issuers face, and how issuers manage VA risks.

He also gave the attendees a look at how fixed indexed annuities with guaranteed minimum withdrawal benefits (GMWB) riders work.

From an insurer’s perspective, he explained, fixed annuities are a funding source for investments. The insurer invests the cash in high-grade bonds, then subtract operating expenses, the crediting rate, and the cost of the options contracts used to manage risk to get the profit margin, or spread, according to Sarfatti’s session slidedeck.

Sarfatti also presented a chart comparing the types of risks an issuer faces when it sells various types of fixed annuities. For a look at five indexed annuity risks Sarfatti described, drawn from the session slidedeck, see the idea cards above.

— Read Proposal Could Ease Variable Annuity Hedging Ruleson ThinkAdvisor.

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