Interest rate spike could whack VA sellers

Just as insurers are beginning to take comfort in strong stock markets and look ahead to rising interest rates, a new risk could bedevil their blocks of variable annuity business.
Life insurers haven’t really confronted the possibility of a dramatic spike in interest rates, which could lead to some variable annuity-related losses at the companies, according to Ken Mungan, financial risk management practice leader at Milliman Inc. He participated on an annuity workshop panel today at the Standard & Poor’s 2013 Insurance Conference in New York.
“One thing I worry about is a spike in interest rates; there isn’t enough emphasis on that,” Mr. Mungan said.
Insurance companies have hedged themselves against low interest rates and market volatility, but a spike in interest rates would throw a monkey wrench into those plans because policyholder behavior would change. Because insurers have been planning for most annuity holders to keep their products, their lapse assumptions would be thrown off sharply should rates rise and other products become more attractive.
“With a spike in interest rates, people would be perfectly happy with a bank [certificate of deposit] or a fixed annuity,” Mr. Mungan said. “A lot of companies could be over-hedging on the interest rate side. They assume the policies will persist, and if rates spike, they may not.”
The chance that policyholders may surrender their contracts in a rising-rate environment is called disintermediation risk, which, in turn, could cause companies to sell assets at a less than optimal time.
Interest rate risk and other factors have placed the overall variable annuity industry in a state of flux. However, just as some major players, such as MetLife Inc., have decided to curtail volumes, others are jumping into the field and looking to build business. Forethought Financial Group Inc., for instance, bought up new business capabilities from The Hartford Financial Services Group Inc. Forethought issued its initial VA contract in the first quarter.
“The VAs coming in today are fundamentally different from those manufactured before the crisis,” Mr. Mungan said. “The new ones have a higher profit margin, lower risk profiles, and the risk management is in the consumer account. [New entrants] are finding it’s a profitable business, and they’re not burdened by old business.”