A.M. Best Special Report: Equity-Indexed Annuities -- Risks Revisited.OLDWICK, N.J. -- A.M. Best Co. remains cautious on the equity-indexed annuity equity-indexed annuity A contract with an insurance company that promises periodic payments keyed in a specified manner to a stock market index. Unlike variable annuities, equity-indexed annuities specify a guaranteed minimum return that is typically 3%. segment due to its thin profit margins and management challenges during the continuing low-interest-rate environment. Nonetheless, A.M. Best believes that some equity-indexed annuity writers have weathered the interest-rate and investment challenges better than others. The equity-indexed annuity has emerged as a choice product for annuity buyers, who are generally risk-averse, long-term investors Long-term investor A person who makes investments for a period of at least five years in order to finance his or her long-term goals. looking to enhance their returns by participating in the equity markets while preserving principal and earning minimum guaranteed returns. This growing demand for attractive, low-risk investment alternatives has led to strong growth in equity-indexed annuities. From the insurers' perspective, the equity-indexed annuity product has sustained its appeal and attractiveness for those annuity writers that are unable or unwilling to market variable annuities Variable annuities Investment contracts whose issuer pays a periodic amount linked to the investment performance of an underlying portfolio. . A.M. Best also notes that its nonregistered nature and the ease of channeling sales through existing distribution sources have facilitated the equity-indexed annuity's continuing success despite its complex structure, potential market-conduct issues and cutting-edge administrative requirements. Product design represents a significant risk for an insurer offering an equity-indexed annuity product. The product design and its embedded features are primary drivers of the company's overall product risk management. Both equity-indexed and fixed annuity Fixed Annuity An insurance contract in which the insurance company makes fixed dollar payments to the annuitant for the term of the contract, usually until the annuitant dies. The insurance company guarantees both earnings and principal. writers continue to face similar challenges in managing the financial risks associated with spread-based products. Disintermediation The elimination of the distributor and/or retailer (the middleman) when making a purchase. The term is used to refer to purchasing directly from a manufacturer's Web site, the benefits of which are convenience, fast turnaround time and sometimes lower prices. risk, driven by policyholder behavior, remains a risk under rapidly rising interest rates, especially when an equity-indexed annuity contract is outside of its surrender charge Surrender Charge A fee levied on a life insurance policyholder upon cancellation of his or her life insurance policy. The fee is used to cover the costs of keeping the insurance policy on the insurance provider's books. period and when more attractive investment opportunities emerge. Spread compression and reinvestment risks Reinvestment Risk The risk that future proceeds will have to be reinvested at a lower potential interest rate. Notes: This term is usually heard in the context of bonds. due to the prolonged low interest-rate environment have pressured insurers' statutory operating earnings Operating Earnings Profits after subtracting expenses such as marketing, cost of goods sold, administration and general operating costs from revenue. Notes: Tax and interest expenses are not subtracted - operating earnings are synonymous with EBIT (earnings before while limiting or straining capital growth. Equity-indexed annuity risks can be mitigated by active product management, especially where certain embedded options in the product design need close monitoring. While the significance of product design cannot be discounted, A.M. Best believes that equity-indexed annuity risk management must follow an integrated risk model that includes hedging, strong asset-liability management, and active market-conduct and compliance programs. A.M. Best believes insurers have a greater awareness of their risk exposure and better understanding of the risk profile of the equity-indexed annuity business. Nonetheless, capital requirements Capital requirements Financing required for the operation of a business, composed of long-term and working capital plus fixed assets. and low returns on assets may pose long-term challenges. Only those companies that have instituted a comprehensive risk-management program may achieve their profit objectives, while others could continue to struggle and may remain vulnerable to financial risks. As a result, A.M. Best remains cautious over the industry's outlook. BestWeek subscribers can download a PDF (Portable Document Format) The de facto standard for document publishing from Adobe. On the Web, there are countless brochures, data sheets, white papers and technical manuals in the PDF format. copy of all full special reports at no additional cost or a combination of the PDF copies plus all related spreadsheet files of the report data at no additional cost from our Web site at http://www.bestweek.com. Nonsubscribers can download a PDF copy of the full special report (8 pages) for $50 or a combination of the PDF copy plus the spreadsheet file of the report data for $100 from our Web site at http://www.bestweek.com. Call customer service for more information, (908) 439-2200, ext. 5742. A.M. Best Co., established in 1899, is the world's oldest and most authoritative insurance rating and information source. For more information, visit A.M. Best's Web site at http://www.ambest.com. |
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