What You Need to Know
- The author observes that many insurers are fixated on ITM.
- He contends that insurers focus on ITM because ITM can hurt their results.
- He proposes that the flip side is that ITM might help the annuity holders’ results.
Insurers are fixated on in-the-moneyness (ITM), so should you be.
There have been several articles published recently about the challenge that insurance companies have in forecasting variable annuity policyholders’ behavior, such as how policyholders manage and make decisions about their contracts. Getting it right is critical to insurers’ profitability.
Their big concern is when a variable annuity contract gets into a deep ITM condition. This happens when the present value of the insurer’s estimated future policyholder income from the contract is significantly greater than contract’s account value.
If policyholders can recognize when this is the case, then an insurer’s assumption is that there’s a bigger probability that the policyholder will immediately exercise the right to start guaranteed income payments, resulting in a loss to the company.
So, insurers are concerned about what decisions your client could make that could have a negative financial impact on the insurers. Or, to flip the coin, what a positive impact these decisions will have on your client’s pocketbook. Obviously, your client would also want to know what these decisions would be, to cause a more positive financial outcome for the client.
How Is ITM estimated?
There’s significant debate as to how to estimate the ITM metric, and even more debate about how much the policyholder might be aware of its magnitude. One thing for sure, though, it’s not a simple calculation.
One school of thought maintains that a policyholder would need an actuary and a couple of programmers to help calculate the ITM metric. In other words, no clue.
Other insurers believe that some policyholders might use a simple proxy, such as comparing the account value to a guaranteed income base.
Others believe that some policyholders or their advisers might have access to a software app to do the job.
ITM, ITM, ITM!
Just like the old real estate advice that the three best reasons to consider buying a property are “location, location, location!”, the big take away from all of this is that insurers recognize that, if a policyholder has a good, continuous estimate of a contract’s ITM metric, this will have the biggest impact on policyholder behavior and therefore, on the insurer’s bottom line.
This leads to a very important truism for these products: If policyholders want to get the most out of their variable annuities, there’s nothing more important than having an accurate estimate of a contract’s ITM.
This is not rocket science. If a contract has significant current ITM and the ITM is estimated not to get any higher, then a policyholder should exercise the income benefit immediately. If a contract has no ITM, and it’s estimated not to ever have ITM, then the contract should be replaced or surrendered, immediately.