In the Wall Street Journal, Leslie Scism reported on what steps insurers are taking to lessen the risk of covering variable annuities with income guarantees. People preparing for their retirement are thankful that they will not lose their principal, but are worried that insurance companies will struggle to cover their guaranteed minimum income benefits in this market.
However, Scism says that annuity providers use a complex hedging process in order to reduce their market risk. In order to offset stock market declines, they buy financial derivatives that are expected to rise when the market falls. Hedges are time-consuming and need to be updated several times during the life of an average long-term variable annuity.
They aren’t infallible; the success of hedging depends on an insurer’s experience and skill. Hedging is becoming more expensive, due to the Fed lowering interest rates and stock fluctuations.