What is Driving the Rush for the Variable Annuity Exit?

The variable annuity industry in the U.S. is highly concentrated.  Ten insurance companies generate roughly 80 percent of industry revenue, and the top 20 companies generate over 90 percent of total sales.

A meaningful signal is sent when five of the top 20 variable annuity companies announce that they are either exiting the business entirely or paring-back existing product lines.

This is exactly what has taken place over the past several months with the following companies dialing down their variable annuity exposure or pulling-out entirely:

• Sun Life
• The Hartford
• Jackson National
• ING
• MetLife

Equity market volatility and low interest rates are the common themes running through the most or all of the retrenching decisions.  There are a few way in which high volatility and low interest rates can hurt the companies that provide variable annuities:

• Poor equity market performance and low interest rates affect the value of guaranteed living benefits which are liabilities for the insurance company.  Poor stock market performance and low rates both increase the amount of the insurance company liability.
• Higher volatility results in higher hedging costs.
• Stock market performance affects the value of separate account assets which, in turn, affects fee income related to those assets under management.
• Many return on equity (ROE) models consider capital market volatility or “beta” as a proxy for risk.  In this context, “extreme” capital market conditions create higher hurdle rates and result in lower return on equity.

MetLife’s recent investor conference call sheds some light on the return on equity issue. During the call, MetLife categorizes its product lines based by level of ROE.  There are three ROE categories: 1) greater than 15 percent; 2) 10 - 15 percent, and; 3) less than 10 percent.

Retail annuities (including variable annuities) are in the less than 10 percent ROE bucket. Included in this less than 10 percent bucket are other capital intensive business lines that require “margin improvement.”

MetLife also alludes to capital intensity and the level of economic capital required in the variable annuity business.  Economic capital refers to the amount of capital that needs to be set aside to deal with the risks in a particular line of business.  Perceived risk is high in the capital markets right now, so economic capital requirements are high as well.

The capital intensity theme was a major factor for The Hartford as well. The argument in favor of leaving the VA business was based on the notion that capital could be allocated to more flexible and less intensive areas such as property and casualty lines.

A point to consider, though, is that all of these value assessments require the assumption that capital market conditions will continue to be as extreme as they have been over the past several years.

MetLife sheds some light on the glass half full perspective when they talk about the potential leverage in their variable annuity business. Some points to consider:

1. As of March 31, MetLife had total variable annuity liability balances of $152.1 billion.
2. $99.9 billion of the $152.1 billion had a living benefit rider
3. Of the $99.9 billion, $78 billion was in the form of a guaranteed minimum income benefit (GMIB) rider.
4. 17 percent of the GMIB riders were in the money as of March 31.
5. The GMIB net amount at risk (the additional money MetLife would need to come-up with if everyone annuitized their GMIB contract immediately) as of March 31 was $1.6 billion.
6. If the S&P 500 were to increase by 10 percent and the yield on 10 year Treasuries increased by 1 percent, MetLife’s net amount at risk and in the money percentage would go “pretty close to 0.”
7. Only 250 out of the 375,000 ($60 billion worth of revenue) variable annuity contracts sold by MetLife over the past 3 years have a living benefit rider that is in the money today.

It seems that recent market volatility and ultra low interest rates could be distorting the perspectives of variable annuity issuers and the perspectives of certain shareholders of these companies.

Maybe the world has entered a permanent state of high volatility and low interest rates. Then again, maybe it has not.  In any event, there is at least a possibility that current perspectives on the variable annuity business are distorted by an overemphasis on recent experience.

Sources: MetLife