Variable annuitiesVariable annuities

Variable annuities

The calculation of the prescribed capital amount for a statutory fund containing variable annuity business must be undertaken in accordance with this Attachment.

2. Variable annuities are a type of life insurance product that has special features that are not adequately catered for under the Standard Method. Accordingly, more sophisticated modelling must be performed to determine the prescribed capital amount for a statutory fund with liabilities for this type of product.
3. The required modelling could be undertaken using stochastic techniques or scenario-based techniques, as long as the techniques are adequate for assessing the risks inherent in the relevant variable annuities. The modelling must consider both asset and insurance risks simultaneously.
4. The modelling of asset and insurance risks must be consistent with the principles outlined in paragraph 30 of this Prudential Standard and LPS 115 and LPS 114 respectively.
5. The following issues must be addressed in determining the prescribed capital amount for a statutory fund with liabilities for variable annuities:
(a) the uncertainty associated with the company’s ability to implement any required hedging strategy in a timely and effective manner;
(b) the effectiveness of hedging arrangements;
(c) the ability to access suitable hedge instruments in the future;
(d) whether a matched asset and liability profile within 12 months can be achieved for this type of product, particularly given the risks that exist for these type of products beyond 12 months, e.g. ratchets and path dependencies;
(e) allowance for any discretions available; and
(f) allowance for management corrective action to achieve a matched asset and liability profile within 12 months.
6. The prescribed capital amount (before addition of the Asset Concentration Risk Charge and the Operational Risk Charge) for a statutory fund with liabilities for variable annuity business must be determined via the following formula:

Capital = E * Capital (including hedging) + (1-E) * Capital (excluding hedging)

where:

(a) Capital (including hedging) = the capital requirement for asset and insurance risks calculated assuming that dynamic hedging is included in the model;
(b) Capital (excluding hedging) = the capital requirement for asset and insurance risks assuming there is no dynamic hedging but allowance can be made for hedge positions that exist at the valuation date; and
(c) E = an effectiveness factor that reflects the level of sophistication of the dynamic hedging in the model.

A dynamic hedging strategy is a hedging strategy that requires frequent rebalancing of the asset portfolio. The Capital (including hedging) and Capital (excluding hedging) may allow for diversification between asset and insurance risks but must not attribute any value to tax benefits that cannot be netted against deferred tax liabilities.