Hedging cushions blow for VAs

While variable annuity performance has plunged this fall, the hedging programs designed to protect the products have helped carriers save $40 billion during September and October, according to a study from Milliman Inc. Variable annuity hedging programs have been approximately 93% effective during the rocky months of September and October, when the equity markets plunged and products linked to the stock markets — including variable annuities — suffered large declines in performance, according to the Seattle-based consulting and actuarial firm. The study, “Performance of Insurance Company Hedging Programs During the Recent Capital Market Crisis,” was written by Peter H. Sun, consulting actuary, and Ken Mungan, financial-risk-management-practice leader, using data from the company’s insurer clients. The hedges buffer insurers’ capital from losses in variable annuities with guarantees. Those products create large liabilities for insurers when the value of the VA account falls and becomes lower than the value of the guaranteed benefits. The two most common hedges are delta/rho, which protects against equity and interest rate volatility, and delta/vega/rho, which protects against equity, interest rate and implied-volatility movements, according to the study. The programs, which don’t necessarily aim to garner a profit for the life insurer, use futures contracts and plain-vanilla options to balance risk, according to the study. Though much of the hedge payoff came from movements in equity and foreign-exchange markets, not all hedging programs were perfect. For instance, the rise in volatility created losses with the unhedged vega, the change in a guarantee’s value related to the change in implied market volatility, according to Milliman.