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24 Jun 2013
New York, June 24, 2013 -- Unpredictable behavior by variable annuity policyholders will continue
to pressure US life insurers going forward, says Moody's Investors
Service in its new special comment, "Unpredictable policyholder
behavior challenges US life insurers' variable annuity business."
US life insurers' inability to predict policyholder behavior including
lapse rates led to mispricing that continues to be a weak spot for the
industry, says the rating agency.
Variable annuities allow customers the ability to invest in a variety
of investment options of their choice, subject to certain limitations.
Since the early 2000s, insurers started selling variable annuities
that guaranteed minimum withdrawal and income benefits, with these
benefits soon becoming very popular.
"Variable annuity sales boomed until the onset of the 2008-2009
financial crisis as customers flocked to the new product; largely
due to the product's ability to offer customers equity-like
returns, a guarantee and a deferred tax benefit, all in one
product," said Moody's Vice President Neil Strauss,
an author of the report.
Experience to date shows that companies selling VA's with guarantees
misestimated and underpriced the lapse rates on this product, as
policyholders held on to their policies at a greater rate than the insurance
companies anticipated. This miscalculation forced insurers to take
significant, unexpected earnings charges and write-downs
over the past year and a half, notes Moody's.
"Life insurance companies correctly assumed that during adverse
market conditions, when the guarantees became valuable, policyholders
would hold on to their policies", added Strauss. "What
companies didn't anticipate and price for was that policyholders
would lapse even less frequently than they had expected."
Moody's points out that though equity market declines are generally
seen as the biggest risk in VA contracts, most insurers effectively
hedge much of that risk via derivatives. The lack of hedge instruments
for policyholder behavior, particularly lapses, is currently
the bigger and less manageable risk. The decreasing number of US
companies offering this product highlights its' inherent pricing
and risk management challenges.
Large, legacy blocks of rich guarantees and risky VA's with
guaranteed living benefits remain on companies' books. Moody's
expects that if interest rates remain low, equities markets fall,
and guarantees stay in-the-money, similar behavior
by policyholders will continue. This will force companies to take
charges in recognition of lower prospective profitability. Although
it is difficult to identify the size, timing, and likelihood
of potential individual company charges, the industry impact could
be in the billions of dollars given the size of this business and the
associated reserves, says the rating agency.
For more information, Moody's research subscribers can access
this report at URL: http://www.moodys.com/research/Unpredictable-policyholder-behavior-challenges-US-life-insurers-variable-annuity-business--PBC_155438
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VP - Senior Credit Officer
Financial Institutions Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
Senior Vice President
Financial Institutions Group
Moody's: Unpredictable policyholder behavior challenges US life insurers' variable annuity business
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
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