Bad investments have heaped the pain on insurance companies’ bottom lines, but analysts and ratings companies are keeping an eye on a different potential “time bomb” that could nail insurers in the near future: variable annuities.
Hard-to-predict liabilities relating to annuity products are making experts skeptical over insurers’ financial strength; chiefly, that companies enticed customers by offering products that came with expensive guarantees. Now, those guarantees could further erode capital and leave companies on shakier ground.
The key word is “could” – both insurers and analysts are uncertain as to how badly, or even if, these guarantees would hurt the companies that sold them.
“You’re trying to hedge a risk that you may not fully understand,” said Rachel Alt-Simmons, a research director with Needham-based TowerGroup. “It could be a time bomb for some carriers.”
Life Adds To Death
Variable annuities, in which the policyholder pays a lump sum in return for periodic payments strung out over time, rise and fall in value depending on how the equities markets perform. Equity markets are tanking right now, which has discouraged potential customers from buying variable annuities. But for those who already hold such policies, it chips away at their investment.
That’s only part of the trouble.
Such annuities previously just carried a death benefit for the policyholder’s beneficiaries if the policyholder died, said Kevin Ahern, a senior director with Standard & Poor’s. But to entice more buyers, companies started attaching a “living benefit” that would allow policyholders to take money out of their principal payment without penalty.
Death benefits are relatively easy to parse; actuarial principles have long worked out risk with regard to mortality-based payments, Ahern said. It’s much harder to say how people will react in, for example, a bad economy, when they have the option to withdraw.
“They’re trying to judge behavior of people withdrawing income. That’s a very difficult risk to manage,” he said. As the market declines, companies will need more capital to support those guarantees. “And it’s not as if the capital is just sitting there.”
Just A Handful
It’s a fairly far-reaching concern, Alt-Simmons said, but it only affects maybe about 40-45 life insurance providers out of the 1,200 in the U.S., because most insurers simply weren’t large enough to offer variable annuity products in the first place.
The trouble is that it’s hard to gauge which companies are in deeper trouble because everyone’s keeping the full extent of their risks under wraps. Meanwhile, companies point to the competition and say “our products are risky but not as risky as so-and-so,” she said. That lack of transparency leaves everyone off-kilter.
Time Still Ticking
But there are some mitigating factors, Ahern said: Policyholders who bought such annuities in the last few years – when such policies were increasingly popular – aren’t able to take any of their principal payments out for five to 10 years. And those who can are only allowed to take out a small percentage annually. That combines to protect insurance companies from losing massive chunks of that money while the markets are currently down.
Still, that’s enough to knock life insurance company financial ratings down a notch or two, he said.
