State insurance regulators are moving ahead with a project that could help keep variable annuities on the shelves — by keeping decreases in the theoretical value of derivatives contracts from making their financial statements look like a blighted soybean leaf.
Publicly traded insurers, especially, fear that “non-economic” changes in derivative contract values could make their earnings look terrible, and force them to narrow, or eliminate, their variable annuity product offerings.
Life insurers use derivatives contracts, or contracts with other financial services companies, to back up variable annuity benefits guarantee promises.
Through many of the contracts, the other companies, or counterparties, have promised to pay cash to the insurers if interest rates fall below a specified level, or rise above a specified level. The derivatives contract promises help a life insurer make sure it can, for example, provide a minimum crediting rate of at least 1% on a customer’s variable annuity account value.
The derivatives contracts, and insurance regulators’ proposed “Statement of Statutory Accounting Principles” (SSAPs) are complicated, but the impact of a lack of change is clear: Increasing interest rates could cause big drops in the fair value of the derivatives contracts, and make variable annuity issuers’ earnings look as ugly as sin.
Some accountants and regulators contend that reflecting the current value of all assets and liabilities in financial statements immediately gives everyone the best picture of how a company is doing.
From the perspective of life insurers, reflecting all of the fair value changes in financial statements immediately would be unfair, because the derivatives contracts would be working exactly as intended: helping variable annuity issuers support minimum crediting rate promises.
The fair value, or theoretical value, of the derivatives would be falling simply because interest rates were moving around, not because anyone had spent paid any cash to anyone, or because the insurer might try to sell its derivatives contracts to someone else.
What Regulators Are Doing
Members of the Statutory Accounting Principles Working Group, part of the National Association of Insurance Commissioners (NAIC), worked on SSAP No. 108, “Derivatives Hedging Variable Annuity Guarantees” last week in San Francisco, at the NAIC’s fall national meeting.
The SSAP would apply only to derivatives contracts used to hedge interest rate risk in variable annuity contracts, and only if the insurer could show that the hedge was “highly effective” at helping it cope with changes in interest rates.