Oliver Wyman Examines Total Asset Requirements for Variable Annuities

A leading actuarial firm is recommending that refining components of regulatory capital and reserve requirements for variable annuities as regulators strive to complete a principles-based approach to reserving later this year.

The presentation was made during a Webinar offered by Oliver Wyman on June 2 titled “Emerging Issues with AG 43 and C-3 Phase II RBC for variable annuities.”

Among the findings discussed during the Webinar is the impact of hedging can often be counter-intuitive. For instance hedging can potentially increase reserves and sometimes overall total asset requirements (TAR.) The report, prepared by Wyman, also finds that the Standard Scenario, a floor that was put into place by regulators to ensure conservatism, “dominates more that may have been originally intended.”
Findings discussed during the Webinar also suggest that the level and volatility of capital requirements have increased with the potential for cyclical changes in results.

One of the consequences of the new regulatory effort could be a greater demand for “engineered capital markets and reinsurance solutions, with an attendant higher cost,” according to the Wyman report.

A surprising finding was that in spite of “well developed, time-tested hedging programs,” a third of companies surveyed did not see a hedging benefit.

The Webinar touched on how the recent financial crisis offered the industry insight into how sensitive the new principles-based approach is to market volatility.
Leading up to 2008, companies generally would have had no capital requirements but these requirements ballooned at the end of 2008, the Wyman report notes.

The question that surfaces is whether the sensitivity is appropriate given the purposes of the solvency balance sheet, according to Oliver Wyman. It continues, saying that “Should markets fall again, requirements will rise steeply—however, a company that is hedging should not see its excess capital position change materially.” Even so, volatility of capital requirements could be exacerbated, the firm adds.

Wyman suggests refining these principle-based regulations and submitting amendments to the National Association of Insurance Commissioners, Kansas City, Mo., by year-end 2010.