New York, June 24, 2013 — Unpredictable behavior by variable annuity policyholders will continue  to pressure US life insurers going forward, says Moody’s Investors  Service in its new special comment, “Unpredictable policyholder  behavior challenges US life insurers’ variable annuity business.”

US life insurers’ inability to predict policyholder behavior including  lapse rates led to mispricing that continues to be a weak spot for the  industry, says the rating agency.

Variable annuities allow customers the ability to invest in a variety  of investment options of their choice, subject to certain limitations.  Since the early 2000s, insurers started selling variable annuities  that guaranteed minimum withdrawal and income benefits, with these  benefits soon becoming very popular.

“Variable annuity sales boomed until the onset of the 2008-2009  financial crisis as customers flocked to the new product; largely  due to the product’s ability to offer customers equity-like  returns, a guarantee and a deferred tax benefit, all in one  product,” said Moody’s Vice President Neil Strauss,  an author of the report.

Experience to date shows that companies selling VA’s with guarantees  misestimated and underpriced the lapse rates on this product, as  policyholders held on to their policies at a greater rate than the insurance  companies anticipated. This miscalculation forced insurers to take  significant, unexpected earnings charges and write-downs  over the past year and a half, notes Moody’s.

“Life insurance companies correctly assumed that during adverse  market conditions, when the guarantees became valuable, policyholders  would hold on to their policies”, added Strauss. “What  companies didn’t anticipate and price for was that policyholders  would lapse even less frequently than they had expected.”

Moody’s points out that though equity market declines are generally  seen as the biggest risk in VA contracts, most insurers effectively  hedge much of that risk via derivatives. The lack of hedge instruments  for policyholder behavior, particularly lapses, is currently  the bigger and less manageable risk. The decreasing number of US  companies offering this product highlights its’ inherent pricing  and risk management challenges.

Large, legacy blocks of rich guarantees and risky VA’s with  guaranteed living benefits remain on companies’ books. Moody’s  expects that if interest rates remain low, equities markets fall,  and guarantees stay in-the-money, similar behavior  by policyholders will continue. This will force companies to take  charges in recognition of lower prospective profitability. Although  it is difficult to identify the size, timing, and likelihood  of potential individual company charges, the industry impact could  be in the billions of dollars given the size of this business and the  associated reserves, says the rating agency.

For more information, Moody’s research subscribers can access  this report at URL: http://www.moodys.com/research/Unpredictable-policyholder-behavior-challenges-US-life-insurers-variable-annuity-business–PBC_155438

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Neil Strauss VP – Senior Credit Officer Financial Institutions Group Moody’s Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653

Scott Robinson Senior Vice President Financial Institutions Group JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653

Releasing Office: Moody’s Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 212-553-0376 SUBSCRIBERS: 212-553-1653