Survival of the Fittest in the Variable Annuity Industry

11/12/2008

The last few months haven't exactly been the best of times for the insurance industry. And this past week wasn't any better. A number of companies stocks took another sharp hit after Goldman's Chris Necaypor released his analysis of the industry earlier this week. On top of that, it seems like ratings cuts may be around the corner for a number of companies if they don't figure out how to raise more capital.

So what does this mean for the VA industry? Well the market for variable annuities certainly isn't going anywhere. There is still a huge mass of baby boomers set to retire over the coming years and the VA will continue to serve as an important component of their investment portfolio. However the landscape of companies competing in the market looks like it may get a face lift..

Darwin's survival of the fittest may indeed be applied to the VA industry. The top 15 players already make up nearly 90% of market sales. The smaller companies fighting for that last 10% may likely exit and sell their business and its possible that an acquisition or two may take place among the larger players ( Necaypor hinted at Metlife & other strong P&C companies being potential buyers). Further more, all signs indicate that the arm's race of richer and richer guarantees is coming to an end.

So what exactly happened this week?

Goldmans' Downgraded a number of insurance companies due to the following reasons:

• Exposure to poor commercial real estate holdings

• Decreased revenue from annuities and other asset based fees products

• Anticipation of capital calls to avoid rating cuts

Ratings cuts... nothing a few Billion can't fix.

Remember the Troubled Asset Relief Program (TARP) - you know that $700 Billion the senate passed through. Initially Insurers not named AIG had taken the position that they didn't need or want any of that. Now it looks as if some insurers have had a change of heart. Lucky for for them, they may be able to claim a stake in it too... well some of them. According to the treasury (who appears to be making up the rules as they go along), some insurance companies may be able to get a slice if they can show they are affiliated to federally regulated banks or thrifts (sounds like the finance version of proving you have Native American blood to get Casino money). Unfortunately, other insurers who expressed interest in this money will be turned away. In their case they may have to resort to more traditional, and likely less desirable means of raising capital, such as:

• Issuing more stock and hoping they find buyers

• Borrow Funds via issuing bonds which would likely be at higher, less desirable rates do to the lowered ratings (see a downward spiral here)

• Merger / Acquisition / Selling off a business line (as a last resort)

So we'll see in the coming weeks who's getting some of government (tax payers) funding and who wishes they were. There has also been some early indications that those who do not qualify for the money may have a few tricks up their sleeves to get on the list.

While Necaypor is not recommending ownership in most of these companies, it's not so bad for the policyholders who have purchased guarantees that are now “in the money” meaning the insurer is on the hook for paying out the difference between the initial deposit (or higher) and the current value in the underlying mutual fund type investments. Most insurers have hedging programs or reinsurance agreements set up to pay for these claims.

In Necaypor's analysis, one company did come out above the rest – Metlife. They seem to be well capitalized compared to their peer group. This seemed to be the rational for Necaypor to issue a “neutral” rating compared to a sell that most of the other companies. But there is still a good chance that Metlife does apply for federal money – not because they need it to maintain their rating, but rather to stock up funds so they can acquire some of the weaker annuity players. Should be an interesting few weeks in the insurance industry...

Source