Risk Professional - December 2009

agers historically have had little say. Competition dictated that U.S. VA players have traditionally underwritten the business with an unlevered 12% internal rate of return based on management assumptions like an 8% annual equity return.

“Variable annuities are not a viable business in the form they were in before, because the guarantees were too exotic, underpriced and unhedgeable,” says Raghu Hariharan, a London-based analyst at Fox Pitt Kelton.

ING, as have others, has a renewed, front-office emphasis on product design and sales sustainability. “Risk management needs to start from the front office,” says Potjes. “All the people from the field need to look at and manage the risks that ING takes – all of them.” says Potjes.

Making dramatic changes to its VA guarantees, MetLife in May reduced its ratchet feature from 6% to 5% and slashed the annuitization period of several GMIB products from 10 to 5 years. It increased the term from 7 years to 10. It also changed its underlying portfolio limits from 85% equity and 15% fixed income, to 70% equity and 30% fixed income. The no-lapse guarantee was pushed out to age 62 from 60. And in

techniques, there are still some economic environments in which VAs may not be a sustainable business.

Take, for example, Japan. The Hartford announced in April that it would sell its Japanese VA business. ING and Lincoln Financial Group are stopping VA sales there this year. Could the U.S. be headed in the same direction?

“You can’t squeeze blood out of turnip,” says Thomas Wilson, CRO of Allianz. “VAs in the U.S. were priced to the bone from the start. It’s uneconomical to completely structural hedge, and then the bigger question is whether you should be in the market.”

The answer mainly depends on whether the U.S. is entering into a long deflationary period with low equity returns. (The recent equity rally may douse those fears, for now.) Potjes at ING, which has reduced its U.S. VA offerings this year, is keeping an eye out for rising interest rates, which would ease some of the pressure on profit margins. But having lived in Japan after 1997, he remains cautious. He remembers the widely held assumption that interest rates were so low they “could only go up.” Japanese 10-year rates were at around 3%. “Now, when

in the United States were priced to the bone from the start.

February, the company increased GMIB prices.

Meanwhile, the Hartford has stopped selling most of its VAs. Its “Lifetime Income Builder Portfolio,” for example, previously allowed for 5% dollar-for-dollar withdrawals before age 59. 5. It guaranteed a return on the underlying portfolio based on a moving scale: 7% for a policyholder between 80 and 84, rising to 8% beyond 90 years old, according to Oliver Wyman.

For some VA contracts, insurers’ ultimate liability could be substantially increased if policyholders maximize the value of their put option by reallocating their whole portfolio to equities and withdrawing immediately. “There is significant uncertainty as to the ultimate policyholder behavior and the potential for adverse selection,” says Oliver Wyman’s Tadros. Going forward, product design needs to reduce, if not eliminate, the possibility of actual behavior deviating from the predicted.

A Strategic Dimension

Incorporating business strategy is another feature of ERM that is gaining greater prominence. Sixty-four percent of respondents to the Deloitte survey said they manage strategic risks. Even with simpler products and more robust hedging

people tell me interest rates are rock bottom and they can only go up, I smile,” says Potjes.

But MetLife’s Rallis points to cultural differences as a reason why inflation might be of greater concern. “Give Americans $1, and they’ll spend $2,” he says. Despite recent gains in personal saving rates, he finds it hard to envision Americans matching the Japanese for frugality. MetLife plans to retain its variable annuity business in Japan, even though it recently sold its company based in Taiwan.

Regardless of where interest rates are headed, it is clear that the firms with the most comprehensive risk management systems – with a focus on regulatory risks, product design and strategy, among other proficiencies – will lay the foundation for better business strategies and reap rewards in years to come.

“It’s not so much about the structure of the organization – you need a culture of risk management,” says Rallis. “It means both understanding your risks and having transparency around the risks you’re taking.”