What happens when historically non-correlated assets quickly move together in the wrong direction all at once? As the 2008 financial crisis revealed, a more sophisticated treatment of correlation was required amongst financial market participants—and many Variable Annuity (VA) writers were left holding a significant bag of unhedged exposures. Realizing most VA hedging programs were overly simplistic and did not consider credit spreads, since that time, the insurance industry has been working hard to hedge risk in a way that is more consistent with market-observed behavior.
What comes next in the evolution of best practices for the complex modeling and intense calculations involved with effectively hedging the risks associated with large VA portfolios?
Is the blending of capital market models with actuarial science considered to be the insurance industry’s new nirvana as they brace themselves to meet complex and frequent calculation demands—along with a slew of growing regulatory, statutory capital and International Financial Reporting Standards (IFRS) requirements?
We are seeing a growing trend in the insurance industry increasingly investing in technology powerful enough to hedge large, complex VA portfolios with embedded options, along with the ability to provide a window into the impact on capital and earnings at risk—more quickly, more frequently and more accurately.
The use of cloud-enabled systems that support the end-to-end risk management and hedging of life insurance and annuity products (VA/FIAs) is on the rise, along with more advanced systems supporting hybrid and nested stochastic frameworks, economic scenario generation, High-Order and Future Greeks—in addition to consolidated platforms for assets and liabilities. For other firms, outsourcing their hedging rather than building or investing in complex technology systems has become an alternative trend in the marketplace.
For further discussion on trends and best practices in VA modeling and hedging, read the recently published Insurance Risk article, entitled “Seen from Another Angle."