Fixed Indexed Annuity (FIA) Reinsurance

Fixed annuity and indexed annuity reinsurance is a market where Ruark Insurance Advisors has significant experience, along with variable annuities and life insurance.  This article reviews the basic parameters that a direct writer should understand in order to evaluate the applicability of fixed and indexed annuity reinsurance to their situation.

Annuity reinsurance is a tool to manage required capital, surplus strain and a company’s balance between asset risks and insurance risks.  Limiting sales volumes can achieve similar results but may conflict with strategic needs to maintain or grow sales volumes and to enhance relationships with distributors.

Quota share reinsurance of all inherent risks is the most common structure.  This is a permanent transaction where the reinsurer would be on the risk for their share of asset performance, disintermediation, expense and persistency; and would receive their share of the evolving profits.  Business covered can be an inforce block, new business flow or a combination.

Most of the reinsurers active in the fixed and indexed annuity market consider investment management to be one of their core strengths, so the direct writer must be willing to include the reinsurer in asset management.  Assets can either stay on direct writer’s books with an agreement on who will manage them, or assets can be transferred to the reinsurer.  If assets are transferred to the reinsurer, Ruark Insurance Advisors recommends that a trust be established for the benefit of the direct writer.  The requirements of such a trust should go beyond the regulatory trust requirements for receiving reserve credit, and should be geared towards the likelihood of the assets in the trust being sufficient to satisfy the reinsured liability.

Fixed and indexed annuity reinsurance programs are time consuming to negotiate.  Prior to considering reinsurance, maintaining and maximizing profits on annuity business consumes significant senior management time.  The direct writer and a reinsurer must develop an understanding of how this management protocol will be shared.  Negotiation of a reinsurance program should be expected to take a minimum of six months, and sometimes considerably longer.

Fixed and indexed annuity reinsurers are not typically the normal North American life mortality reinsurance players.  Ruark Insurance Advisors can help a direct writer identify appropriate reinsurers.  Treaty terms and structures vary, with heavy reliance on negotiations specific to the facts and circumstances of each direct writer’s situation.  Ruark Insurance Advisors has the experience to guide our clients through these discussions.


Plotting Risk Management: The Variable Annuity Market in Five Acts

The 21st century actuary -- highly trained expert in mathematics, finance, insurance, and risk management; quantitatively astute skeptic and business person; playwright -- wait a minute.  Perhaps we’re getting carried away.  The actuary as playwright?!

Yes, it’s quite possible, in a manner of speaking.  Let’s consider the plot arc of the last decade of the variable annuity market in five acts.

First, the exposition:  in the United States, variable annuities are tax-favored retirement savings products with a central investment component, often accompanied by additional guarantees in the form of a death benefit or lifetime income stream.  Fundamentally, the purpose of these products is to help individuals manage their retirement savings through tax-deferred investment earnings in the accumulation phase and a lifetime income stream in the retirement phase.

The action rose as these products evolved dramatically from their earliest forms decades ago:  what was once a handful of simple mutual fund-like investments with the benefit of tax deferral was replaced by a dizzying array of investment options surrounded by dozens of types of guaranteed death benefits and lifetime income benefits.  In the years leading up to the financial crisis, product competition and growth were very strong, with sales increasing from $129 billion in 2003 to $184 billion in 2007 (source:  LIMRA).  With these volumes, variable annuities transformed from a complementary product line to a position at center stage for the insurance companies offering them and for the insurance industry at large.

The financial crisis was the climax, and exposed the massive and complex risks embedded in these products.  As global equity markets and interest rates declined precipitously, the value of the guarantees that were provided to variable annuity policyholders increased in value, but the value of insurers’ investment assets failed to keep up.  The industry buckled, as several companies reported losses of hundreds of millions of dollars, and many that had been leaders in variable annuity sales significantly curtailed or closed to new sales.  Sales dropped to $128 billion in 2009.

In the falling action since then, the industry seems to have gradually and reluctantly found a new normal, with “de-risked” products featuring more modest guarantee features around simpler investment options, with higher charges to policyholders.  Sales have increased to $147 billion in 2012.  But this is hardly a resolution.  As a result of the last decade of drama, shareholders, regulators, and rating agencies have become keenly aware of the risk dynamics for these products.  In spite of a reasonable recovery in terms of sales and product re-design, the industry still has about $2 trillion of inforce variable annuity assets of the old vintages that were so problematic during the last financial crisis (source:  IRI).  What is to prevent the next financial crisis from triggering catastrophe for the variable annuity market?

That is the question for the variable annuity industry.  And it is most pointedly the question for its actuaries.  How will these actuaries, uniquely qualified through their powerful combination of quantitative risk management skills, business savvy, and insurance heritage, write a creative denouement that avoids a tragic ending?  I’ll share mine in the next post.

Uncommon Sense

The funny thing about this risk management stuff is that everyone is supposedly doing it already. In business, from the solo practitioner or individual employee, to the department manager, to the chief executive, everyone has their internal compass as to what they should be doing or avoiding, or what specific result would constitute failure or success. Most people call this common sense.

Find XBut common sense can be surprisingly uncommon and inconsistently applied. Modern principles of risk management emphasize the importance of laying things out explicitly, in advance, taking actions that are consistent with these objectives, then monitoring progress and making adjustments over time. Sometimes the actions need to be adjusted, but sometimes the objectives do too. Even the most well thought out plan and risk management strategy will need to be changed eventually. Here is where we can easily slip off into abstract philosophical ruminations or highly technical risk management methodologies that would be virtually impossible for most business people to implement. I’m more of a pragmatist so let’s just start with the idea of questioning our assumptions, which is the bedrock of a sound risk management strategy.

 

Fragile or unrealistically precise assumptions are very dangerous things, and can lead well- intentioned business people astray. A simple example that I have seen repeatedly is the assumption that a new company can make a lot of money by entering a very large and mature market, if they can just eke out a tiny market share. It’s so tempting – surely we can get at least 0.5% market share, and with a $100 billion market, that’s $500 million in sales for us. Yes, there are large start-up costs, but once we break in, our profit can be $50 million annually in five years! This siren song is always accompanied by detailed financial projections, under baseline assumptions and stress tests. Ostensibly, this is good risk management practice, as the assumptions are explicit. But all too often I’ve seen these assumptions insufficiently justified, the stress tests not broad or severe enough, and the risks inadequately addressed.

 

This is where the actuary – the quantitatively astute skeptic and businessperson – can be invaluable. The actuary recognizes that market share is a function of how you distinguish yourself relative to competitors, and this is amenable to quantitative and qualitative analysis. The actuary needs evidence for assumptions, and can trace them back to specific operational actions or broader business conditions. The actuary recognizes that numerical assumptions should only be considered as placeholders for a range of possible outcomes, not an exact prediction; deviations can be multiples of the original assumption, not just plus or minus 20%. The actuary recognizes that these deviations represent risks to the business and should be managed attentively, not hoped away. And here’s the best part: the actuary is equipped to help manage these risks, sometimes through operational actions, sometimes through investment transactions, and sometimes through insurance transactions. Common sense meets modern risk management – now that is a powerful combination.