Due To Market, VA Benefits Now Giving Issuers Headaches
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Given the current fist-clenching stock market gyrations, the question is: Who has the whiter knuckles–life insurers, contract holders or stockholders?
Life insurers may well be hanging on the tightest if the market continues to plummet, according to interviews, earnings conference calls and rating agency outlooks.
Sobering news from companies is leaving no doubt that if the market continues to drop, guarantees–particularly the guaranteed minimum death benefit in variable annuities–and deferred acquisition costs are going to hurt life insurers and, if the companies are public, their shareholders.
Guaranteed death benefits are immensely popular with consumers, interviews suggest.
Currently, 596 of a total of 600 variable annuity contracts offered by insurers, have, at the very least, a death benefit of return of premium, according to Rick Carey, editor of the VARDS Report, an Info-One service, in Roswell, Ga. The guaranteed minimum income benefit is also quickly becoming a popular feature, with 122 of 600 contracts offering them, he adds.
As these guarantees have gained in popularity, their costs have been lumped into an accounting liability called "deferred acquisition costs" along with bonuses and upfront commissions. DAC allows an insurer to amortize a cost over time rather than to recognize the expense during a given accounting period.
In a strong equity market, assets grow and liabilities can match that larger total. However, when the market drops, assets under management follow suit and liabilities must also fall to match assets. Consequently, DAC deferrals are accelerated and large expenses start to show up on the income statement.
These factors were threaded through a review of second quarter results last week when Nationwide Financial, Columbus, Ohio, and Hartford Financial Services Group, Hartford, Conn., fielded questions from analysts during their respective conference calls.
Hartford Financial said individual annuity operating earnings were down 7% over last year due to lower asset fees. The VA sales environment is "challenging," the company said, with year over year sales down 7%. Hartford said it remains comfortable with its DAC and GMDB exposure.
On its call, Nationwide said its exposure to GMDB claims is $5 billion, 15% of a $33 billion book of VA business. Of that total, $2.9 billion or 58% is reinsured and 42% or $2.1 billion is backed by reserves.
Nationwide also addressed its DAC exposure. It currently has $3.3 billion of DAC on the balance sheets, of which 60% is accounted for by individual annuities.
Should the equity markets continue to reflect July performance, Nationwide said it is possible there could be a 4th quarter 2002 or 1st quarter 2003 impact to earnings of between $175 million and $200 million after-tax. If that were to happen, the company said, full-year earnings estimates of $3.25-$3.40 per share in 2002 would be revised downward to $3.15-$3.20 per share.
The two calls followed a downgrade of Allmerica Financial Corp. by Moodys Investors Service, New York, and negative outlooks on several companies from Standard and Poors Corp., New York.
S&P issued negative CreditWatch warnings on American Skandia Life Assurance Corp., Shelton, Conn.; The Phoenix Cos., Hartford, Conn.; Sun Life Assurance Co. of Canada, Toronto; and Allmerica Financial Corp., Worcester, Mass., because of the markets potential impact on their equity-linked products.
Info-Ones Carey, a variable annuity veteran, says the current environment is a "real-time test" of the product, accounting issues related to it and the relationship of VA issuers with their brokers.
"There will be a significant shakeout" over the coming years, Carey predicts. Products, product features and related accounting practices that dont pass muster will be gone, he adds.
Part of that change will be an assessment of insurers relationships with their brokers, he continues. Under the current model, Carey says that contracts sold through brokers have a shorter time period to recoup commissions: 5-6 years as opposed to 8-9 years for a captive agent. Brokers have to have new products to offer customers and do not want to be in products as long, he explains.
Colin Devine, managing director, with Salomon Smith Barney, New York, says the good news is that GMDBs "did put value in the product and we are seeing that now."
