Insurer strength secures GMWBs

Investors have been seeing the ugly side of guaranteed products these days. Arguably, the most popular guaranteed investments — guaranteed minimum withdrawal benefit (GMWB) products — remain quite firmly guaranteed as long as their issuer’s balance sheet can carry the risk.

Many PPNs and some guaranteed target-date funds that use constant proportional portfolio insurance (CPPI) strategies have converted themselves into fixed income products to cover their maturity guarantees. This is because the product is typically funded from within the product’s asset mix.

As the market has dropped, these products have converted to protection status, where they essentially become fixed-income products that will be able to pay an investor’s guarantee at maturity — but will probably not deliver any upside beyond that. The issuer protects its liability by eliminating the upside risk/reward potential of the investment.

Concern has started to mount in the industry that segregated fund products and GMWBs, which have a heavy equity weighting, could suffer a similar fate. However, it’s not the product bearing the risk, explains Roy Firth, executive vice-president, individual wealth management for the Canadian division of Manulife Financial; it’s the issuer’s balance sheet.

“The balance sheet of the issuer of that [product] makes sure these benefits are paid back on the life of the product. It’s a process that is reviewed every quarter,” Firth says.

Because the issuer is the party taking on the equity risk, it has to put more money into its reserves when markets decline. The only concern for the investor about guarantees is whether the insurer can service those requirements.

In the U.S., there have been some serious questions about this. In fact, a report released by U.S. research firm TowerGroup outlined this as one of the biggest challenges for U.S. insurers, which now have very high reserve liabilities for variable annuity products.

“Investors are really concerned about the risks a lot of these companies are taking on the guarantees associated with those products. As the market goes down, insurance companies are basically on the hook for that gap on the guarantee,” says life insurance company analyst Rachel Alt-Simmons, TowerGroup’s research director for insurance. “These companies need to raise more capital to support their reserves and the products they have sold. Right now the market isn’t listening to that. Your options are limited to what you can do to get more money.”

In Canada, things remain relatively stable. Manulife’s issuance of an additional $2.125 billion in equity, through a “bought deal” and private placement, underscored its ability to turn to the market to meet additional pressure on its product reserves.

To meet Canadian seg fund reserve requirements is a considerable testament to an issuer’s strength, the Canadian Institute of Actuaries points out.

“Canadian regulators require companies to maintain available capital that is at least 150% of minimum required capital and companies set a target level that is typically around 200%,” the Institute said in a statement to Advisor.ca. “This means that the total amount of capital earmarked for these products is usually double the minimum required capital. In effect, this provides an increased level of confidence that the company will be able to pay all guarantees when they come due. The strong Canadian regulatory framework should give consumers comfort that, in almost all cases, their insurer will be able to meet the guarantees when they come due.”

Manulife, for example, expects a loss for the current quarter, the first in its short history as a public company, to cover those reserves. Its liabilities for its variable annuities business have ballooned from $526 million to approximately $5 billion. Firth says it is a testament to the company’s strength that even in an extraordinary downturn like today, it can still more than meet its liabilities on these products.

“In Canada, what we’ve reported in the financial disclosure the other day that we had in aggregate in $5 billion in reserves against these products, $2.7 billion will be reported in fourth quarter,” he says. “[Because these are directly tied to the market] it’s fully expected that amount in fact will flow back into earnings as markets improve.”

He underscores the underlying asset mix for these products will remain strongly tied to equities. It’s in the interest of the insurer to maintain that so they can relieve pressure on the product reserves when there is an upswing.

Still, it raises questions as to whether issuers may be looking to ratchet down their benefits and maybe increase fees in the future. In the U.S. this process is already underway. Firth says the U.S. issuers tended to be quite a bit more zealous in offering incentives and features in products.

“The different features in the U.S. kept getting escalated. The products in Canada are somewhat more conservative than the ones in the U.S. I can’t speak on all of them, but overall the Canadian market has maintained a balanced product mix that provides fair value for the client,” he says. “Products will adjust over time, and will be refined. They aren’t going to change dramatically.”

(12/05/08)