A.M. Best Analysts Weigh In on Potential Regulatory, Financial Impacts of NAIC Contingent Annuity Debate

A.M. Best Co. analysts weighed in on the possible financial and regulatory impacts to insurers depending how the National Association of Insurance Commissioners ultimately comes down on the longevity risk-protection products dubbed contingent deferred annuities.

Recently, a majority of the members of the Contingent Deferred Annuity Subgroup recommended to the NAIC's Life Insurance and Annuities (A) Committee that contingent deferred annuities are life products that should be written by life insurers, Felix Schirripa, chair of the Contingent Deferred Annuity subgroup, told Best's News Service. CDAs provide a guarantee of lifetime income, albeit triggered only after the depletion of the policyholder’s own covered funds. Further, managing lifetime income guarantees requires expertise that resides with life insurers.

These products resemble the guaranteed lifetime withdrawal benefit rider on traditional stock market-linked variable annuities, said Schirripa (Best's News Service, Feb. 23, 2012). However, the subgroup also thinks these products "present risks that are akin to those in financial guaranty insurance," but a majority believed that property/casualty companies "should not be allowed to write them," he said.

The subgroup no longer calls them "hybrid income annuities" but rather what the industry has been calling them—contingent deferred annuities, which are the stand-alone guaranteed lifetime withdrawal benefits on covered assets administered outside an insurance company. GLWBs have been sold with traditional variable annuities for years, Schirripa said.Steven Schwartz, an equity analyst with Raymond James, said the debate surrounds contingent deferred annuities sold on non-VA or noninsurance products, such as mutual funds. Mutual funds can't sell lifetime guarantees, only life insurers can, so a mutual fund company contracts with a life insurer to guarantee the funds, Schwartz said (Best's News Service, Feb. 23, 2012).

"Although the structure of a CDA is different from a traditional variable annuity with a GLWB rider, "the financial risk profiles of the two products are similar," said Andrew Edelsberg, vice president at A.M. Best. Both provide a guaranteed basis for lifetime income; however, the VA account value base is administered by the insurer within the separate accounts, while the value of the covered assets for a CDA are administered outside the insurance company, Edelsberg said.

“Because a high proportion of VA sales are driven by withdrawal benefit riders, there could potentially be an impact on VA sales if consumers want the longevity protection on mutual fund holdings without having to purchase VAs, which contain other fees and charges, but offer more benefits,” said George Hansen, managing senior financial analyst/actuary at A.M. Best.

Hansen also explained that, from an insurance company perspective, there are other sources of fee revenue within VAs; specifically, mortality and expense fees. These fees provide a cushion in the event that GLWB rider fees are too low. Also, there is more control of funds within VAs as companies have been limiting policyholder account allocations. For CDAs covering mutual funds, control of funds may be more difficult. Additionally, monitoring policyholder behavior (e.g. utilization, withdrawals, lapses) is a challenge and there is no other fee revenue to fall back on.

Another concern Hansen noted, is the willingness of mutual fund companies to allow CDA’s to be attached to their funds, which could lead to draw downs of assets on which they derive a significant portion of revenue.

The subgroup believes that if these products are viewed as annuities, the current AG 43 reserve requirements and C-3 Phase 2 capital requirements for VAs are appropriate for CDAs. There may be higher risks with CDAs as other fees present in VAs will not be available to cover any shortfalls. “These higher risks will result in higher reserves and capital under the current framework of AG 43 and C-3 Phase 2 requirements” Hansen said. Others contend that if the insurance company does not have control of the assets being guaranteed, then reserves may not be adequate as other risks emerge.

The reserving guidance in AG 43 "is fairly broad and could easily be extended to products like [contingent deferred annuities]," Schirripa said. However, the subgroup is suggesting that reserving requirements need to be looked at by the regulators more carefully (Best's News Service, Feb. 23, 2012).

The two biggest U.S. life insurers appear to be on opposite sides of the debate: MetLife views CDAs as financial guaranty insurance while Prudential Financial contends they're similar to a living benefit rider on a variable annuity.

“If there can be adequate controls, regulatory understanding from all parties—the mutual funds, insurance companies, and fund holders—then these products can fill a void of longevity protection,” Hansen said.

The A committee could reject the subgroup's recommendation outright or appoint a new working group but that group "would have a lot to do," Schirripa said.

(By Fran Matso Lysiak, senior associate editor, BestWeek: [email protected])