Following a reasonably successful 2011 and indications that policy writers are becoming more sophisticated when assessing policy holder risk reward profiles, developed market VA products have regained some of their lustre lost since 2008. This may encourage Chinese policy makers in their implementation, but key challenges remain - both in improving VA product risk controls generally and reforming the tax regime to facilitate VA uptake. 

In November 2011, China Insurance Regulatory Commission awarded its third approval for a VA product to Huatai Life Insurance. The approval, the largest to date at RMB4 billion ($631 million), marks another incremental step forward in China’s VA market development and is also part of a broader drive to increase voluntary pensions participation. Over the summer, Axa-Minmetals and Sino-US United Metlife had been awarded approvals of RMB916 million and RMB2.9 billion respectively.

But Chinese policy makers and dominant industry players are likely to proceed with caution given the divergent international experiences of VA policy writers in recent years, according to Lillian Zhu, a senior analyst at Z-Ben Advisers. “So far, only Sino-foreign JVs whose foreign shareholders have experience of such products have launched VA products. The larger domestic players haven’t shown interest in VA yet. It’s hard to see any scheme expansion of late or in the near future.”

For example, European VA policy writers operating in the US have faced considerable challenges in the post-Lehman environment, above all poor equity market performance and enhanced policy-holder risk aversion. Some VA products have failed to justify their additional policy-holder fees, as Roger Breeden, a Principal at Mercer in London points out.

“Fees are one of the big challenges. Paying for guarantees is expensive and due to the low level of Defined Contribution account balances (average still less than￡30,000 in the UK) there wasn’t much scope for growth. People require maximum immediate income - the majority buy fixed non escalating annuities. Those with larger account balances have generally had sufficient assets to allow them to operate income drawdown to focus on succession planning rather then seeking underlying guarantees. A further challenge is the regulatory position. Advisers would need to review the underlying investments for their clients on a regular basis and this drives additional costs with a consequent reduction in return.”

Moreover, leading names such as Hartford, AXA and ING have been forced to substantially restructure or even abandon their VA operations in the UK and US.

However, according to a recent report by Barclays Capital, the last few years’ US VA vintages could offer better risk reward profiles than their predecessors. Policy writers are becoming more sophisticated and better able to model policy holder behaviour, meaning they could become better able to identify “in-the-money” (ITM) policies and vintages over time.

 “Assumed utilisation rates remain untested and assessing policyholder behaviour looks very difficult, particularly in the current economic climate. In our view, the next 12-24 months are crucial as the first real behaviour data-points begin to emerge on the blocks of business now exiting the initial waiting period,” wrote Barclay’s analyst Toby Langley.

The report goes on to compare the performance of European VA providers operating in the US. Three - Metlife, Prudential Financial and Jackson National - have increased their market shares by two to three times since 2008. Meanwhile, AXA’s market share has halved and the company has undertaken a wide-ranging restructuring of its VA business, while ING have exited the space completely. Both AXA and ING had previously held the top ranking in the US market, reflecting the substantial changes that have been seen in terms of industry composition since the global financial crisis.

These divergent fortunes demonstrate that, for insurers, a key question when evaluating the pros and cons of writing VA products is which type of benefit guarantee to select. For European insurers in the US, the largest gains have been by Jackson National, Prudential’s local subsidiary, which has increased it market share from about 4% to just under 12% in the last three years, with its clear preference for guaranteed minimum withdrawal benefit (GMWB).

The growth of GMWB products suggests policy holders are attracted by the flexibility rather than being forced into buying an annual annuity. Meanwhile, AXA have preferred guaranteed minimum income benefit (GMIB), while ING’s back-book is divided roughly equally between GMIB/guaranteed minimum death benefit (GMDB), GMWB/GMDB and GMDB. 

But while the four major benefit guarantee types have their respective strengths and weaknesses, China’s regulatory regime remains under-developed for exploring these options in full. Z-Ben’s Zhu identifies four more fundamental challenges for China’s tax regime:

    New accounting rules: funds raised from VA won’t be included in insurance premiums so insurers are reluctant to launch such products.

    Tax incentive policy: China lacks tax incentive policies for pension insurance.

    Investment: many insurers’ investment capabilities are limited; insurers don’t have enough hedge tools.

    Experience: most of domestic insurers don’t have any experience in managing VA, but some joint ventures can take advantage from their foreign shareholders.

Given these obstacles and the inherent risk aversion of the regulator, the introduction of Chinese VA products is likely to continue at its current, cautious pace.

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