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Variable Annuities

Last Updated 10/04/19

Issue: A variable annuity is an annuity contract that allows the policy owner to allocate contributions into various subaccounts of a separate account based upon the risk appetite of the annuitant. The contributions can be invested in stocks, bonds or other investments. Income payments in the annuitization phase can be fixed or fluctuate with the investment performance of the underlying subaccounts of the separate account. In contrast to fixed annuities, policyholders assume all of the investment risk with variable annuities because they are separate account products that are valued at market every day. Additionally, variable annuities are registered as securities with the Securities and Exchange Commission (SEC).

Overview: Insurers began marketing variable deferred annuities in the late 1970's in response to rising interest rates and equity markets. Unlike the fixed deferred annuities insurers mostly sold up until this time, variable annuities offered investors the ability to hedge against this rising inflation. Because variable annuities are backed by assets held in an insurer's separate accounts, their income benefits fluctuate with the investment performance of the underlying separate account investments. Originally, variable annuities underlying investment funds primarily consisted of corporate common stock, but as time went on, insurers expanded their fund offerings to include bonds, indices, mutual funds, and other securities. This enabled policyholders to move funds between various subaccounts to achieve a certain investment strategy.

To boost sales, insurers began offering variable annuity products with guarantees about a decade ago. Since then, there have been a plethora of guarantees introduced to the market, with most insurers now offering various minimum guarantees. These guarantees can ensure the policyholder receives minimum death benefits, guaranteed living benefits, accumulation benefits, minimum credited interest rates, and income benefit or withdrawal benefit amounts. Variable annuities with guarantees provide an important differentiation to other alternative investments such as mutual funds, which is their biggest competitor.

Sales of both group and individual variable annuities rose in the 1980s. Demand for annuities in general increased significantly after the Tax Reform Act of 1986 reduced the tax advantages of qualified retirement plans. Individual variable annuities became particularly popular. A CIPR Study on the State of the Life Insurance Industry notes that by the mid-1980s, growth in individual annuities had resulted in insurers' overall product mix becoming almost evenly distributed between annuity considerations and traditional insurance products. By the end of the century, annuity products, led by variable annuity sales, had become so popular their sales volumes outpaced those of traditional life insurance. The result would be an historic shift in life insurers' overall product mix toward annuities.
However, low interest rates and equity market volatility of the past decade have placed pressure on the returns for variable annuity products. It has also hurt insurers' ability to support variable annuities, many of which were issued with minimum guarantees. Insurers have responded by reducing their guarantees and crediting rates to accommodate the new environment. Despite these economic pressures, variable annuities continue to be in demand, particularly as aging consumers seek savings vehicles designed to help them manage their long-term needs. As such, sales of variable annuities will remain an important source of revenue for insurers in the future.

Status: State insurance regulators monitor the solvency of insurance companies offering annuities and have strict rules in place, some of which are derived from NAIC model laws and regulations. The NAIC encourages states to adopt model laws and regulations designed to inform and protect annuity consumers. The NAIC Annuity Disclosure Model Regulation establishes standards for the disclosure of certain information about annuity contracts to protect consumers and foster consumer education. The NAIC Suitability in Annuity Transactions Model Regulation sets forth standards and procedures for recommendations to consumers that result in a transaction involving annuity products to ensure the insurance needs and financial objectives of consumers are appropriately met at the time of the transaction.

The NAIC Life Actuarial (A) Task Force is charged with identifying, investigating and developing solutions to actuarial problems in the life insurance industry. The Task Force adopted changes to Actuarial Guideline XLIII (AG43) and VM-21, Requirements for Principle-based Reserves for Variable Annuities to implement the Variable Annuity Framework adopted by the Variable Annuity Issues (E) Working Group in 2018. The implementation included development of additional variable annuity reporting requirements in VM-31, PBR Actuarial Report Requirements for Business Subject to a Principle-Based Valuation.

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