Variable Annuities Are Risky Business—Fitch Ratings
October 25, 2008
Persistent adverse equity market conditions will continue to pressure the earnings and risk-based capital levels of U.S. life insurers active in variable annuities, according to Fitch Ratings.
In a new report, “2008 Financial Turmoil Increases Variable Annuity Risk,” Fitch states that the capital needed to support the variable annuity business of U.S. life insurers has risen to $15 billion this year-to-date because of the significant decline in the equity markets. The profitability of the products has also been negatively impacted by reduced fee revenue due to lower net asset values, increased hedging costs and reserving associated with product guarantees.
“Fitch is concerned that insurers are overly optimistic about the effectiveness of their hedging programs, which have not been tested under prolonged adverse market conditions,” the reports states. “Given record highs in implied volatilities, the cost of purchasing derivative contracts to support hedging programs will rise and adversely affect net income. In addition, the performance of these hedge programs will suffer as pricing assumptions did not forecast this elevated volatility.”
The conditions have weakened so much that Fitch predicts a number of insurers will “rationalize” their VA business. This means that larger players that have had brisk sales over the past few years could now cut back on variable annuities and refocus their energies on other product lines; smaller players will be forced to sell or run-off their VA business.
For more information on the study, visit fitchratings.com.
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