OLDWICK, N.J.--(BUSINESS WIRE)--Changes geared toward reducing non-economic volatility in the calculation of reserving and capitalization levels for certain variable annuity products could eliminate the need for these U.S. life/annuity insurers to use captive reinsurance to manage risks.
Misaligned elements under current reserving and capitalization practices have challenged the ability of life/annuity writers to effectively manage the risks associated with minimum guarantee benefit products, according to a new Best’s Special Report. In an effort to reduce the resulting non-economic volatility, variable annuity writers reinsure this business with affiliated captives, in order to better align risks with hedging programs.
Efforts underway by the National Association of Insurance Commissioners (NAIC) would modify these reserve and capital requirements so that non-economic volatility is diminished, according to the report, titled “Current VA Reserve and Capital Requirements Challenging L/A Insurers.”
The NAIC has worked in conjunction with Oliver Wyman, which has conducted two quantitative impact studies with large variable annuity writers and made recommendations to the NAIC in December 2017. Regulators and other industry groups are reviewing these recommendations; the timing of final implementation of the changes is difficult to determine at this point.
A primary recommendation involves changing the accounting treatment for such hedges to better align them with the respective liability. Hedges are currently marked to market, leading to non-economic volatility. Amortizing the cost of hedges over a period closely matching the liabilities will minimize this volatility, according to the Best’s Special Report.
Although the recommended changes will help fix various flaws in the existing framework, the potential for greater volatility in the equity market will challenge variable annuity writers. Hedging is not the only answer, but the solutions available are limited, as reinsurance has dropped off, according to the report.
“The use of captive reinsurance is likely to decline significantly, as a result of the recommended changes,” said George Hansen, senior industry research analyst. “So long as true economic values and those of various accounting regimes differ, the use of alternative financing methods will continue.”
Data from A.M. Best’s supplemental rating questionnaire highlights the status of variable annuity reserve and capital components through 2016 and illustrates the conservative reserving relative to capital that can result under the current framework. A.M. Best’s SRQ data also tracks the funding status of guaranteed minimum benefit riders attached to variable annuities, and with recent market gains, the guaranteed withdrawal amounts still exceed the account values on hand at year-end 2016 compared with other guaranteed benefits.
The report notes that variable annuity writers have increasingly hedged products with guaranteed minimum withdrawal benefits since 2011, but these have the least exposure when compared with three other types of guaranteed minimum benefits. Variable annuity products with guaranteed minimum death benefits remain the most exposed, creating more exposure to mortality risk.
To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=273756.
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