Analysts Grade Variable Annuity Issuers' Stormproofing

Life insurance company executives sounded calm when they talked about how their annuity operations did in the fourth quarter.

No major life reinsurers or derivatives counterparties raced into liquidation.

Analysts at Moody’s Investors Service say they looked hard at the issuers’ fourth-quarter financial statements and believe that the issuers’ variable annuity units really did hold up well.

The stock market volatility during the quarter was the worst life insurers have seen since the 2008-2009 financial crisis, and the volatility did cut variable annuity units’ adjusted earnings by an average of 27%, Laura Bazer and other Moody’s analysts write in a new variable annuity performance report.

But “hedging programs performed within expectations,” the analysts write.

Because the derivatives contracts and other financial arrangements annuity issuers used to manage stock market volatility risk worked properly, the issuers’ overall net income looked good, the analysts write.

“Although consolidated net income is a crude measure of VA profitability, it is at least a directional indicator of VA earnings health,” the analysts write.

Here are five more things the Moody’s analysts are saying about how variable annuities held up during the fourth quarter of 2018.

1. General financial reporting rules make comparing variable annuity issuers hard.

Issuers tend to calculate “adjusted earnings” in different ways. The rules for calculating net income are more standardized.

One challenge, the Moody’s analysts say, is that many issuers do not break out net income figures for their variable annuity units.

Another challenge, they say, is that, even though net income calculations are standardized, it’s not entirely clear that net income is a good measure of how a properly hedged variable annuity unit is doing.

2. The effects of the Tax Cuts and Jobs Act of 2017 make it hard to use risk-based capital (RBC) ratios as a measure of variable annuity issuer performance.

In theory, an RBC ratio is supposed to show about how risk insurance regulators think an insurer really is, given the riskiness of its assets and the size of its obligations.

But today’s variable annuity issuer RBC ratios are hard to compare, partly because new capital calculation rules are phasing in, and partly the TCJA has changed some of the items included in RBC calculations, the analysts write.

3. Variations in state rules make comparing issuers in different states hard.

Some states have different rules for how issuers should include hedging in RBC ratio calculations than others, and some let issuers shift variable annuity volatility risk to captive reinsurers that are not subject to National Association of Insurance Commissioners’ reporting rules, the analysts write.

Different reporting rules apply when an insurer’s hedging strategy is considered effective or not effective.

Some states let at least some insurers decide for themselves whether their hedging strategies have been effective, the analysts write.

4. Issuers have different kinds of risk control mechanisms built into their variable annuity products.

The analysts note that some issuers now focus on selling variable annuity products with no guarantees, or only narrow guarantees.

Other issuers protect themselves against extreme market meltdowns by promising to buffer holders only against a pre-set level of account value loss, not to guarantee access to a minimum level of benefits in all scenarios, the analysts write.

“Although insurers have provided few details about how these mechanisms actually functioned through the volatility of Q4 2018, based,again, on the preliminary statutory results, they appear to have kept volatility at bay, preventing guaranteed benefit obligations from mounting and capital from falling further,” the analysts write.

5. The fourth quarter of 2018 was not a worst-case scenario.

The analysts note that the latest quarter was a good test of variable annuity issuers’ hedging strategies, but not necessarily an indicator of how the hedging strategies would perform in an extreme meltdown.

“A severe equity market downturn (such as a drop of 40%), coupled with declining interest rates (down 100 basis points) and high and persistent equity market volatility would test all equity-sensitive businesses (such as pensions, asset management, and variable life) ,including the [variable annuities] of even the best-hedged insurers,” the analysts conclude.

Why Variable Annuity Hedging Matters to Agents

Whether variable annuity hedging programs work properly will affect how profitable the products are for life insurers, how eager insurers are to write new variable annuities, and how eager insurers are to pay you commissions to sell new variable annuities.