Variable annuity market overheats : insurers look to reduce their risk

By Ian Bolduc | August 12 2009 06:28PM

In recent months, the financial crisis has shaken up the variable annuity market and its guaranteed minimum withdrawal benefit plans (GMWB). The product won Canadians over quickly, but volatility in the stock markets has forced insurers to be more prudent. Many insurers have reduced the guarantees offered in their investment products.

Desjardins Financial Security (DFS) has taken the most drastic step by suspending sales of its guaranteed minimum withdrawal benefit (GMWB) plan on its Helios line in July.

The company says it intends to review the characteristics of this product in order to reduce the risks it's assuming, and make certain that it will be able to pay the future income payments promised to clients.

In an interview with The Insurance Journal, Alain Bédard, Senior Vice President of Individual Insurance and Savings at DFS, says that he anticipates the product will return in a different form "some time in 2010."

DFS has gone back to the drawing board in order to come up with a guarantee that will be less risky for the insurer, but still appealing to the consumer given the other products available in the marketplace.

"At this juncture, will the revised product still be called guaranteed minimum withdrawal? Will the guarantee carry a new name? Will it be a combination of the other options that we have? We are studying all the options," says Mr. Bédard.

The GMWB suspension does not mean the insurer intends to pull out of the market. "We want to do an overhaul of the product, taking into account the experience that we've had," he says, adding that since last year, the sales of Helios contracts have surpassed the company's expectations in both the number and the rate of growth.

In 2008, DFS saw an increase of nearly 72% in the sales of its individual savings products. Among the star products was the Helios GMWB, which registered total sales of $315.8 million. "If sales had continued at that level for several years, we would have had some problems. So, we decided we had better take a look at this right away to make certain that our future profitability will not suffer as a result," says Mr. Bédard.

At DFS, the net sales of seg funds went from $39 million in the first six months of 2008 to $357 million during the same period in 2009, according to data collected by Investor Economics, a research firm specializing in investments funds. That's an increase of more than 800%.

As for assets under management, it reached nearly $1.2 billion as of June 30, 2009. This is an increase of 62.7% since the end of 2008.

Mr. Bédard now expects that there will be a decrease in sales of the Helios product, but still believes that the product offers other appealing guarantees. "There's bound to be a certain disappointment amongst advisors, but people understand and see the other options inside Helios."

The decision to stop sales of the GMWB option follows the suspension of the 100/100 r guarantee, which protected 100% of deposits at maturity and at death. This suspension is also temporary. "It is part of the revisions that we are going to carry out for 2010," says Mr. Bédard.

He adds that the financial crisis has had a considerable impact on the insurer's GMWB option. "Did we see this financial crisis coming, the severity of which hasn't been seen in the last fifty years? Did we include this element in our risk management models? Certainly not. But we are adjusting them now that we have recognized it," he says. In fact, Mr. Bédard confirms that DFS' risk management models will be more conservative in the future. "It's a trend in the industry, more so in the United States, but also in Canada."

In the last year, DFS has introduced two new characteristics to its Helios contract. First, in July 2008, the insurer introduced a 7% annually bonus. Then, in December 2008, the insurer added the guaranteed lifetime withdrawal benefit (GLWB).

Why add a bonus and a guaranteed life annuity benefit only to suspend the guaranteed minimum withdrawal a few months later? "When we introduced those options, the financial crisis and its extent had not yet become apparent. The development process takes about six months between the creation of a product and its launch in the market," he explains.


According to Mr. Bédard, the principal characteristics of the GMWB that will be analysed are the bonus amount paid to the client, the frequency of automatic guarantee resets, and the composition of the underlying funds. "These elements all interact with each other and according to the type of funds you have under your guarantee, the level of risk can be very different," he says.

At 7%, the bonus rate in the Helios guaranteed minimum withdrawal benefit is the most generous in the market. It applies if the client has not made any withdrawals during the first ten years after taking out the policy. Most other insurers offer a 5% bonus over a 15 year period.

"It might be riskier for an insurer to give a higher percentage over a short period of time than it is to offer a lower percentage over a longer period of time, but if it is, it should be reflected in the price of the product," comments Iassen Tonkovski, Senior Analyst at Investor Economics. The bonus increases the amount of funds available to the client during the withdrawal period.

In addition, there is an automatic reset on the anniversary date of a Helios contract with a GMWB, at which point the protected capital is compared to the market value. If the market value is higher than the amount guaranteed by the product, the guaranteed value is increased in order to match the market value. This also augments the amount guaranteed for the client at retirement.

DFS offers this reset every year, while all other players only offer resets ever three years. "It is riskier to do it every year compared to doing it automatically every three years. The contract does become riskier of course, but that has to be something that the company has evaluated in the price," says Mr. Tonkovski.

As for Mr. Bédard, he says that DFS will also take a close look at the line of funds covered by the guarantee. "Small cap funds with a guarantee on top of it, that's more risky than a bond portfolio," he adds.

The way the withdrawal period is structured will also be evaluated. At the moment, DFS distributes 7% of the protected amount each year for the first 14 years after the beginning of payments. The income rate then drops to 2% in the 15th year.

Existing clients

Clients who already hold a contract that include the GMWB and who wish to make an additional deposit can either remove the GMWB option from their Helios contract to invest a supplementary lump sum, or convert the GMWB into a guaranteed lifetime withdrawal benefit (GLWB) provided they are aged 45 or older. By doing so, they can make a new contribution. In the GMWB guide designed exclusively for advisor use, DFS says that this change would only be advantageous to the client when the stock market is rising.

This strategy "is for the client who wants to have all his funds managed under a single contract. Otherwise, there's little advantage in taking this route," says Mr. Bédard.

With the GLWB, the client does not automatically receive annual income payments of 7% as is the case with the GMWB. Instead, the income percentage varies according the age at which the client begins withdrawals. The GLWB starts out at 4% if the initial payments are made at 45, but can be as high as 7% if the retiree begins receiving income at age 85.

Clients who are making regular deposits as part of a pre-authorised payment program are not affected by the temporary halt imposed by DFS so long as the program was put into place before July 15. Nevertheless, they may not increase their contribution amounts. Only reductions in deposits, changes in frequency, or the stopping of contributions entirely will be permitted. Clients may continue to make changes to the funds that make up their portfolio.

The Insurance Journal contacted several insurers to obtain their remarks on Desjardins' suspension of GMWB sales. They declined to comment.

Reconsidering guarantees

Several insurance companies that offer segregated funds have had to change tack in the last few months. "It was not a surprise for us," remarks Mr. Tonkovski. "We expected that there would be changes and it is expected that there will be more in the near future. Some of the sponsors that have not yet come with modifications will eventually do so." In recent months, insurers have increased fees or have modified elements of their product in order to protect their capital and improve their profitability.

That's the case with Sun Life Financial. For new segregated fund contracts issued after July 31, the company is requiring clients keep 30% of their portfolio in fixed income investments. For existing contracts, clients have until December 31, 2011 to make the change.

Sun Life has also suspended the sale of the 100/100 guarantee option. As for the fees charged for the GMWB, they have increased from 0.1% to 0.3%.

For its part, Manulife Financial announced in January several measures to reduce the risk of its segregated funds. The insurer has reduced the number of available funds from 77 to 38 for new GIF and GIF Encore contracts.

The company no longer offers the 100% maturity benefit guarantee for equity funds in these products. It has also closed GIF Encore Series 1 to new deposits and transfers. These modifications, however, do not affect its GMWB product IncomePlus.

Transamerica Life Canada and TD Asset Management stopped issuing new TD Guaranteed Investment Funds II segregated fund contracts on March 11, 2009. Current policyholders have not been able to make new deposits since April 15. This decision is the result of market volatility, according to the presidents of the two companies.

Speaking at a risk management seminar for life insurers in Toronto on June 9th, Julie Dickson, head of the Office of the Superintendent of Financial Institutions (OSFI), issued a warning to life insurers about segregated fund guarantees. She noted that the liabilities are not fully known since they change with market movements as well as with resets. Furthermore, the cost of funding the liabilities can also vary depending on whether hedging is used and how the premiums are invested.

"This is a potentially troubling double whammy," said Ms. Dickson. "Given the risks that have become apparent with segregated fund guarantees, OSFI expects companies to fully analyze this business and take necessary steps to manage the associated risk."

The risks that insurers face also affect their reserves. When asked if DFS had a hedging strategy for reserves backing its GMWB, Mr. Bédard replied that it's an element that is part of the risk management review. Did DFS have a hedging strategy before the temporary halt? "That's an element to be considered, but considering that our assets were quite low, it had little impact at that stage," he continued. Mr. Bédard maintains that there is no shortfall to be made up in DFS' reserves. "They are adequate," he says.

Mr. Tonkovski of Investor Economics notes that life insurers' reserves remain very well capitalized. In his opinion, it's not a problem at the moment. "Canadian insurers are very well capitalized," he says. "They're very healthy. So I wouldn't say it's an issue right now."

Not all insurers can say the same. At his farewell speech as CEO of Manulife, Dominic D'Alessandro explained to shareholders that the collapse of the stock market at the global level has, since the fall of 2008, created a shortfall between the guaranteed value of deposits made in variable annuity and the assets which secure these obligations.

According to Mr. D'Alessandro, at the end of December 2008 the shortfall had reached about $27 billion for all of Manulife's worldwide business activities. That's the reason why the company increased reserves for it's GMWB and segregated funds to $5.8 billion when they had only been $526 million the year before. In doing so, the company reached one of the highest capital levels in its history thanks to a series of new share issues made over recent months.

In an interview with, a sister publication of The Insurance Journal, David Paterson, Vice President of Public Affairs at Manulife, noted that at the insurer's last annual general meeting the new CEO, Donald Guloien had made it a priority to "increase capital to fortress levels" in order to offset the effects of ongoing volatility. The interview was held after the Ontario Securities Commission had served the insurer with an enforcement notice, saying the insurer had not adequately disclosed the risks associated with its variable annuity guarantees.

Mr. Paterson added that the drop in interest rates has also thrown off actuarial assumptions. The lapse rate assumptions have also been off. People are keeping their policies longer than expected, and this requires a higher level of reserves.

About face and prudence

On Nov. 4, 2008, Standard Life Canada did an about-face by deciding not to launch it's GMWB product in 2009 as it had originally intended. At the time, the insurance company said it had delayed the launch because of the economic crisis. Standard Life has yet to announce when it will add this guarantee to its product line-up. The company says that its primary concern is to make sure advisors can rely on the product for the long term.

Launch plans

RBC Insurance plans to launch a GMWB towards the end of this year or in the beginning of 2010. RBC maintains that it decided to wait a little before launching the guarantee after noticing that the first products to arrive on the market presented risks that were too high. The company intends to act carefully so that volatility does not lead to problems with reserves. Moreover, RBC Insurance president and CEO Neil Skelding expects that GMWB fees will continue to rise in the market across the board.

"Today, in the seg funds industry," says Mr. Tonkovski of Investor Economics, "the main challenge is to be able to deliver a competitive product without necessarily getting too aggressive. Otherwise, it could lead to an arms race which could prove damaging for the industry. If you continue to produce some aggressive products, but then the price is not reflective of the higher risk that you're being exposed to, then potentially, a company may find itself in trouble down the road."