In responding to the Life Insurance and Annuities (A) Committee (the "A Committee") of the National Association of Insurance Commissioners ("NAIC") request for analysis, the American Academy of Actuaries Contingent Annuity Work Group ("CAWG") issued an October 28, 2011 letter concluding that contingent annuities (i) are logically classified as annuities and (ii) provide needed longevity risk protection to consumers. CAWG's letter included an analysis of:
- The classification of contingent annuities;
- The ability to regulate contingent annuities under existing regulation; and
- The consumer need for the guaranteed lifetime income products.
Set forth below is an overview of CAWG's analysis of these issues.
Contingent Annuities are not Financial Guaranty Insurance or Property/Casualty Insurance:
In its well-reasoned analysis, CAWG concluded that contingent annuities are neither financial guaranty insurance nor property/casualty insurance. In so doing, CAWG focused on the risks being assumed by insurers and contrasted contingent annuities from financial guaranty insurance and property/casualty insurance. It concluded that contingent annuities should be classified as a type of annuity product.
CAWG noted that contingent annuities provide protection against longevity risk whereas financial guaranty insurance provides protection against a specific financial loss - most commonly bond default. While contingent annuities contain an element of protection against financial loss, financial guaranty insurance contains no element of life contingency or longevity insurance. Additionally, CAWG noted, that contingent annuities' protection against financial loss is not a promise as to a specific amount of value of the covered assets, as is the case with financial guaranty insurance. Rather, contingent annuities provide insurance protection with respect to a specified life. Most interestingly, CAWG equated the covered assets under contingent annuities to a deductible -- which deductible must be exhausted before the annuity pays any benefits. CAWG found that the primary characteristic of contingent annuities is longevity risk and the relationship to the covered assets is indirect. Thus, it concluded that contingent annuities should not be classified as financial guaranty insurance.
In performing its analysis, CAWG simulated the payment of claims under a range of market return scenarios and based upon average life expectancy and above-average life expectancy. Because the average size of the total claims paid under above-average life expectancy exceeded that under average life expectancy by 68%, CAWG concluded that contingent annuities provide a material level of protection against longevity risk in addition to market risk. CAWG concluded that the life insurance industry and not the property/casualty industry has the expertise and experience to manage life expectancy risk. Accordingly, contingent annuities should not be classified as property/casualty insurance.
Contingent Annuities are Similar to GLWBs and Can Be Similarly Regulated:
CAWG reviewed the main features of contingent annuities as well as variable annuities with guaranteed living withdrawal benefits ("GLWBs"). It found that there were many similarities between contingent annuities and GLWBs, as follows:
- Consumer protection against longevity risks by providing a guaranteed lifetime income stream.
- Consumer protection against market risks.
- Insurer ability to manage the basis risk, when the necessary contractual and operational controls between insurer and asset manager are in place.
- Similar suitability and disclosure issues.
The differences, on the other hand, are who owns the assets and the standalone nature of contingent annuities.
Because CAWG concluded that contingent annuities are substantially similar to GLWBs, based on its considered judgment, CAWG asserted that the same regulatory framework that applies to GLWBs could be applied to contingent annuities.
Consumer Need for Contingent Annuities:
CAWG determined that contingent annuities can be beneficial for many consumers in that they protect against outliving the consumers' assets through the guarantee of lifetime income. CAWG noted the need to find solutions to protect against longevity risk. Moreover, given the decline in access to, or attainment of, assured lifetime income for a growing number of Americans, contingent annuities provide another solution to consumers for lifetime income. CAWG recognized financial stability in retirement is more attainable when guaranteed lifetime income is available. Thus, CAWG supported more broad availability of contingent annuities.
At the NAIC Fall 2011 National Meeting, the A Committee's agenda includes a discussion of contingent annuities and next steps and will likely focus on CAWG's well-reasoned analysis in its October 28th letter.