Connecticut regulator rejects VA criticism

Connecticut insurance commissioner Thomas Sullivan has rejected calls for variable annuity (VA) guarantees to be accounted and regulated as financial options consistent with those in the derivatives market, and said he was "satisfied" with the performance of supervised companies under the existing regime, which he had no plans to change.

This was despite The Hartford, a Connecticut-based insurer, posting a quarterly loss of $1.2 billion (£730 million) in the first quarter of 2009, after an overall $2.7 billion loss in 2008. The firm is a large provider of VAs, and was hit by many of the guarantees in these products falling in-the-money as equity markets and interest rates plunged at the end of 2008.

Like others that had been hedging their earnings on the underlying funds, it switched to hedging the statutory capital that these guarantees were eating away, mitigating the outflows. It has subsequently abruptly pulled out of overseas sales of the products, although it remains active in the US, where it plans to expand its VA fleet in the third quarter of 2009.

Some industry figures have blamed regulatory regimes that allowed for the use of historical parameters and actuarial models based on policyholder rationality for systematic underpricing and mishedging of the guarantees.

"There is an advantage towards more aggressive pricing," a senior industry figure told Life & Pensions. "Treating embedded options differently to their financial equivalents is why people are unwilling to hedge properly. The fragmentation of US regulation has exacerbated this, allowing insurance companies to have weak hedging programmes or go unhedged."

However, Sullivan rejected these arguments. "I don't think more fair value accounting of these guarantees would have led to better risk management. I worry about changing accounting rules. I'm satisfied with the regulatory and business models in use."

Indeed the regulator's chief actuary, John Purple, rejected the notion of a VA guarantee as a financial option. "I would not characterise them as financial options in that the counterparties are not technical people, but regular people like you and me who are not always going to be as efficient in exercising those options. What happened in 2008 was an extreme tail event, and we don't require companies to reserve for tail events. You can't dynamically hedge this over the lifetime of these guarantees."

Carey Hobbs, head of derivatives strategies in market risk management at the US subsidiary of Amsterdam-based insurer ING, sees the risk management benefits of fair value accounting for VAs. ING experienced lower hedging losses on VAs relative to its peers and Hobbs said it was fair value accounting that had forced companies to hold hedging assets that helped their capital position as markets dipped. "Fair value aligns accounting with the balance sheet. Companies that had managed in fair value could deploy proceeds from their in-the-money hedges during the crisis." By contrast, under a traditional approach companies were left having to raise capital.

But Sullivan said there were many causes for the woes of VA underwriters, but cited expanding product features as one. "In the industry's quest to capture the market share of aging baby boomers, producers all tried to out-innovate each other with ever-richer guarantees, and thereby left themselves more exposed to the downturn."

He praised the performance of Connecticut's insurance companies in the crisis. "Their acuity in managing risk is better than most. The industry has taken a shot in the belly, but the companies' risk management strategies have held up under extreme pressure."

The New York Department of Insurance declined to comment, citing an upcoming review of VA regulation by the National Association of Insurance Com-missioners.