For several hundred years, the insurance industry has offered a tremendous variety of life insurance products. Some of these life insurance products are aimed at providing investment possibilities, such as with-profits endowments and annuity products. These products typically provide substantial investment guarantees, which is one of their main advantages, along with tax privileges and the fact that the assets are managed prudently.
The success of these products can be traced back to the fact that together with the distribution model, directly approaching potential customers, these products are ideal for the clients that are either less sophisticated in planning for their retirement, or do not want to invest efforts in this planning or have avoided to address this topic at all.
But there are some clear disadvantages, which may not be relevant to all, but to some customers and the forces of competition lead companies to develop new products, which addressed these disadvantages, which are:
- The opaqueness of the investment process
- The lack of customer-control over the investment process
- The not sufficient profit sharing of returns above the investment guarantee – and the opaqueness of this profit sharing mechanism
Over time it has become apparent that there is an additional disadvantage from a company perspective, which is the substantial required risk capital these products generate due to the guarantees they provide.
All these problems can be addressed with so-called unit linked products – at the expense of not providing investment guarantees any more.
Unit-linked products invest the savings part of the premiums of the policyholder transparently in investment vehicles, mostly internal or external funds and let the policyholder participate fully in the investment returns of these funds – the upside as well as the downside.
While these products clearly address the issues mentioned above they typically do not provide any investment guarantees any more.
The obvious step now is to build investment guarantees into unit-linked products – this is what Variable Annuities provide.
Variable Annuities combine the advantages of traditional life insurance products – long term investment guarantees, with the advantages of unit-linked products – transparency of the investment and full upside participation.
This of course comes with a price:
- The policyholder has to pay a premium for the additional investment guarantee
- The shareholder has to manage the substantial risks generated by such products
Nevertheless these products have had a tremendous success in the US and in the past few years we have seen these products being offered in the European markets. These products are new to Europe, except in some locations, where they have been widespread, eg, Switzerland, and have generated a lot of interest as they can address the weaknesses of the traditional life products.
New sales volumes are encouraging and we can witness the creation of a new product class, after the unit-linked products have entered the European market some decennia ago.
This book will cover:
- History of VA market
- Current VA market environment in North America, Europe, Australasia
- Valuation of VA contracts
- Risks and Risk Management of VAs
- An analyst and rating agency’s view of a VA writer
- Insurance regulations governing VAs
- Liquidity in global derivatives markets
- Effectiveness of hedging programs during the market turmoil
Published in November 2009, Variable Annuities is the practitioner’s guide to managing risks in this trillion-dollar global market.
This new book provides, for the first time, a comprehensive analysis of the variable annuity marketplace, the use of these products and the challenges associated with the risk-management of these products that have been compounded by the recent financial crisis.
In Variable Annuities more than 25 leading market experts reveal how industry tools are changing, how strategies are being reshaped; and how techniques are being enhanced.
Written by practitioners for practitioners, detailed chapters explore:
- Identifying and quantifying risks: including methods for tackling actuarial/policyholder risks, basis risk, valuation of contracts and guarantees
- Risk management strategies: the use of product design to manage risks and reduce unhedgeable exposure, reinsurance contracts and OTC instruments
- Hedging: hedge efficiency, measuring effectiveness, lessons of the crisis
- Product types and markets: North America, Japan, Europe and Asia-Pac
- Accounting and regulation: the challenges of IFRS and GAAP
With over 25 leading expert practitioners, Variable Annuities covers all aspects of this expanding market and will be the DEFINITIVE guide for:
- Risk managers
- Investment bankers
- Stock/credit Analysts
- Software developers for risk-management solutions
Tigran Kalberer and Kannoo Ravindran
SECTION 1: VARIABLE ANNUITY PRODUCTS
1. History and Development of the Variable Annuity Market
Mike Kaster; Marianne Purushotham
Kaster Actuarial; Watson Wyatt
2. North American Variable Annuities
3. Australasian Variable Annuities
4. European Variable Annuities
Lukas Ziewer; Yves Lehman
Oliver Wyman; Societe Generale
SECTION 2: IDENTIFYING AND QUANTIFYING RISKS UNDERLYING VARIABLE ANNUITIES
5. Risks Underlying Variable Annuities
6. Valuation of Variable Annuity Contracts
Vinay Kalro, Jay Blumenstein and Joe Zhao
7. Valuation of Variable Annuity Guarantees
8. Models used to Quantify Market Risks in Guarantees
9. Models used to Quantify Actuarial/Policyholder Behavioural Risks in Guarantees
Tze Ping and Matt Wion
Ernst & Young
SECTION 3: MANAGING RISKS IN VARIABLE ANNUITY PRODUCTS
10. Overview of Commonly Used Risk Management Strategies
11. Using Product Development to Manage Risks
12. Using Reinsurance to Manage Risks
13. Using Capital Markets to Manage Risks
14. Putting it all Together – from Dynamic to Static
Annuity Systems Inc.
SECTION 4: MONITORING AND REPORTING RISKS IN A VARIABLE ANNUITY HEDGING PROGRAMME
15. Measuring and Reporting Hedge Efficiency
16. Measuring the Effectiveness of a Hedging Strategy
17. Experiences and Lessons Learnt – Does Hedging Work?
Mun Kurup and Warren Manners
18. Issues Relating to Running A Hedging Programme
Annuity Systems Inc
SECTION 5: ACCOUNTING AND REGULATION
An Overview of Insurance Regulations
20. Accounting: IFRS and GAAP challenges
SECTION 6: OTHER RELATED TOPICS
21. Quantifying and Managing Basis Risks
22. Replication Portfolios and Hedging
23. What do Analysts look for when Evaluating Companies Writing Variable Annuities?
24. What do Rating Agencies look for when Evaluating Companies Writing Variable Annuities?
25. Liquidity in Global Derivatives Markets
Naveed Choudri and Edward Tom
Kannoo Ravindran (Ravi). Since pioneering the use of derivatives to manage market risks embedded in variable annuities at a time when writers of such risks used only traditional reinsurance/retrocession or took on the risks naked, Ravi has been working on all aspects of variable annuity risk-management (including managing such risks on a total account value exceeding USD 100 billion) and product development. He currently also chairs the Equity Based Insurance Guarantee Conference Series held annually by the Society of Actuaries globally.