NEW YORK - Reinsuring increasingly is being used to handle equity-related risks associated with the variable annuity guarantees that have flooded the market, but hedging remains the primary method of handling guarantee risk, industry observers agree.
MetLife Inc. said last month that it transferred a "large block" of its VA guaranteed minimum death benefit risk to Paris-based bank Societe Generale. The bank formed a reinsurance company - Catalyst Re Ltd. in Bermuda - to handle the transaction.
The unit assumes some of the equity-related risk in exchange for a share of the premium.
Although New York-based MetLife touted the transaction as the "first of its kind" for the industry, Hartford Life has been using reinsurance for its annuity guarantees for years, according to Tim Benedict, a spokesman for the Simsbury, Conn.-based company.
"We utilize reinsurance for our variable annuity death benefits and living benefits such as guaranteed withdrawal benefits," he said.
But other big VA companies aren't using reinsurance for their guarantee risks.
"We have a hedging program in place to address that issue," said a company spokesman for AXA Financial Inc. in New York.
"At this time, we aren't reinsuring our guarantees," said Patty Reiners, assistant vice president of Ameritas Direct in Lincoln, Neb. "We use other risk-management techniques."
A bank-owned reinsurer - as opposed to an established, traditional reinsurance company - was chosen because a bank has more experience managing mutual fund and equity market risk, according to Andy Rallis, vice president and senior actuary of MetLife.
"A key benefit of the structure is that it provides protection against severe equity market downturns," said Marshall Greenbaum, director of Societe Generale. "It can be used for all variable annuity benefits, including guaranteed minimum income and withdrawal benefits."
VA guarantees can help clients by making sure that there will be a certain level of death benefits or investment returns, regardless of stock market performance. But clients - and their advisers - may be concerned about whether insurers will make good on the guarantees, which haven't been triggered by a major stock market downturn.
Even more concerned are the owners of the insurers - shareholders of stock companies and policyholders of mutuals - who wonder how a plunging market that in turn triggers the guarantees will affect insurers' financial stability.
"Investors [in insurers] are not happy with the guarantees," said Eric Berg, senior life insurance analyst at Lehman Brothers Inc. in New York. "They see trouble, increased risk and a major change in the life insurance business."
Shareholders are worried because the guarantee riders haven't yet been tested in a down market, Mr. Berg added. "They say to themselves, 'Suddenly we're in the business of managing market risk,' and they don't like that."
Hedging, implemented to wholly or partially offset the guarantees' risks, are investments that inversely correlate with stock market performance. Insurers expect the gains from those investments to cancel out stock market losses.
Reinsurance is another way of allaying concerns over guarantee risks.
"MetLife is committed to managing and hedging the risk associated with all the riders on its variable annuity products," Mr. Rallis said. The reinsurance transaction gives the company long-term economic and capital protection, he added.
This reinsurance arrangement is part of MetLife's overall risk management program for its guarantees, and the insurer will continue to use hedging, according to a company spokesman.
Up until now, hedge programs have been an integral part of most living benefit guarantees by insurers, according to Tim Hill, consulting actuary and principal with Seattle-based Milliman USA Inc. "Hedges have been part of guarantee product development from conception," he said.
About three-quarters of variable annuities contain a guarantee, and that figure will continue to grow, Mr. Hill said.
Shareholders worry about whether the guarantees are adequately priced and whether the hedging techniques that the insurers have implemented for the guarantees will actually work, Mr. Berg added. "If something blows up, they are hoping that it won't be their company."
Detailed risk management of the guarantees is part of the discussion that insurers have with industry analysts and financial-rating firms, Mr. Hill added.