Why Variable Annuities Scare a Fed Economist

Lawmakers in Washington are working on bills that could reduce the role of federal financial systemic risk managers in overseeing life insurers.

But at least some economists still believe that, whatever happens in Congress, some life insurers still engage in activities that, in theory, could rattle the U.S. financial system.

Yaron Leitner, a senior economist at the Federal Reserve Bank of Philadelphia, talks about his concerns in a paper in a recent issue of the bank’s quarterly economics journal. Leitner has written papers in the past about topics such as government bailouts of private financial institutions, stress testing, and ideas about why financial markets freeze.

(Related: 5 Peeks at a Hot New Variable Annuity Guarantee Paper)

In the new paper, Leitner gives economists and bankers a general overview of life insurance company activities that could, possibly contribute to financial instability. He agrees with life insurers’ premise that traditional insurer efforts to protect people against death and longevity create little risk for the rest of the financial system.

Leitner argues, however, that some life insurers have branched out and do things that could add to national financial problems when overall conditions are already bad. He says one of the activities that could make bad conditions worse is offering variable annuity living benefits guarantees.

A full copy of the paper is available here.

Some in the life insurance industry have argued that bank-centric economists tend to be easier on banks because they’re usually closer to banks. Leitner, for example, works for the Federal Reserve Bank of Philadelphia, not the Federal Life Insurance Company of Philadelphia. But his views could influence colleagues who, in many cases, may also have more experience with banks than with life insurers.

Here’s a look at five things Leitner says about his concerns about variable annuity living benefits guarantees.

1. Offering variable annuity living benefits guarantees is not a traditional insurance company activity.

Life insurance agents may think trying to help retirement planning clients earn a decent return, while protecting the clients’ assets against a stock market crash, is a commonsense extension of letting variable annuity users control the investments used inside the annuities.

Leitner says the problem is that life insurers use their own assets, or “general account assets,” to back the minimum living benefits guarantees.

“These guarantees may kick in during an economic downturn, as when equity prices drop, adding stress to an already-stressed economy,” Leitner writes.

2. The VA guarantee obligation total has been growing.

Many insurers that were in the variable annuity market have talked about getting out of that market, adjusting the guarantee options available with new products, and, in some cases, finding ways to pay annuity holders to give up benefits guarantees.