In the report A question of legacy: Managing and measuring behavioral risk in variable annuities, Oliver Wyman explores the nature of the behavioral risk management issues faced by companies with substantial variable annuity portfolios and the potential impact of policyholder behavior on earnings and capital in the coming two years. The report also offers recommendations for how the industry should invest in the measurement, management, and communication of behavioral risk. The observations are based on extensive work in product design, risk management, and hedging across most of the major variable annuity manufacturers.

The findings are discussed as the life insurance industry is about to observe a tidal wave of behavioral experience data, unprecedented in its potential impact on earnings and capital. Many firms are woefully unprepared to analyze, communicate, and respond to this data.

Key messages in the report include:

• We estimate a multibillion dollar impact on industry reserves and capital during the next two years, with significant variance in results across the major manufacturers, as approximately $200 billion of variable annuity business with guarantees exits the surrender period.
• Many standard risk management functions, most notably hedging, are not optimized given the degree of uncertainty in policyholder behavior. Without meaningful risk reduction, substantial hedge program transaction costs could result.
• Investments in capabilities to measure behavioral risk and to forecast and communicate behavioral expectations are sorely needed. These investments are needed to ensure that external stakeholders, many of who remain rattled, maintain confidence in insurers as managers of a business viewed asan engine of growth for a generation to come.

The report is 16 pages and has six exhibits.