A.M. Best Co. remains cautious on the equity-indexed annuity 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 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. 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 writers continue to face similar challenges in managing the financial risks associated with spread-based products. Disintermediation 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 period and when more attractive investment opportunities emerge. Spread compression and reinvestment risks due to the prolonged low interest-rate environment have pressured insurers' statutory operating earnings 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 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.
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