New York, March 12, 2014 — Despite the recent equities rally, variable annuities still negatively impact the balance sheets of the three largest variable annuity writers, says Moody’s Investors Service in its latest report “Prudential, Jackson National, and MetLife: Headache from Legacy Variable Annuity Business Lingers.”
“Balance sheet headaches are lingering long after the end of the financial crisis,” says Scott Robinson, a Moody’s Senior Vice President. “The steep drop in equities during the financial crisis prompted insurers to increase reserves and capital to offset risk linked to variable annuities, and although risk exposures have decreased, they are still substantial.”
Variable annuity policies are sold to investors by insurers as a mutual-fund investment vehicle and most offer various protections against market declines for an additional fee.
Using Hedging Programs to Protect Capital
The report examines three of the largest variable annuity writers—Prudential Financial, Jackson National, and MetLife—and gives a high-level overview of the companies’ policies containing guaranteed living benefits. In the report, Moody’s performs a simplified stress test of this business using publicly available information.
Moody’s says these three companies rely heavily on their hedging programs to protect capital in the event of a sharp and immediate downturn in the equity markets.
MetLife’s guaranteed-related claims risk from its block of variable annuity living benefits is similar to that of Prudential or Jackson. However, MetLife has the most diversified book of US insurance business of the three.
Of the three firms, Jackson currently offers the least de-risked product, since it allows contract holders to allocate 100% of their variable annuity assets to equities, a volatile asset class. Jackson’s overall US business is also less diversified than that of Prudential or MetLife, making the effectiveness of its hedging program regarding variable annuities of increased relative importance, says Moody’s.
Prudential is well positioned from a risk management perspective, as relative to the other companies, its variable annuity block is dominated by the auto-rebalancing feature, a positive from a credit perspective. Somewhat offsetting this benefit, Prudential’s product has a daily ratchet, which is more frequent than competitors, says Moody’s. Ratchets lock in investment gains, and add significant risk because they prevent a rising equity market from lowering the company’s guarantee risk.