Why are variable annuities at risk for the guaranteed benefits they provide to their policy holders?
It has to do with taking money vs. holding money. When an insurance company sells a variable annuity they take a client's money and give it to someone else. That "someone else" is usually a stock or bond mutual fund. Therefore, the only way a variable annuity insurance company can make money is to charge fees on the premium as it “passes through their hands”.
A compounding problem for the variable annuity insurance company occurs in a prolonged downward market. For example, if a client deposits $100K into a variable annuity but then that account is decreased to $50K due to market losses, the guaranteed benefits will remain the same (or may even increase) but the fees are reduced by 50%. (i.e. a 3% fee on $100K is $3,000 and a 3% fee on $50K is $1,500).
If a declining account value due to market loss wasn't a big enough problem, another problem is the fees themselves. Fees in variable annuities can be very significant and are a major factor in eroding the account value. In a period of loss, or little to no growth, fees will have a compounding effect on account value deterioration. Once again, the lower the account value the lower the fee revenues for the insurance company. It's somewhat ironic that the more a variable annuity insurance company takes from its clients via fees the less money there is to generate fee revenues.
Consequently, variable annuities can not only be risky for their policy holders but also risky for the insurance companies that sell them.
In contrast, when an insurance company sells a fixed or fixed indexed annuity not only is the principle guaranteed but the insurance company holds on to the money. They assume the risk of investment but the principle is always “in their hands” and always available for them to invest for returns (less the interest rate credited to the account value). For this reason they are able to provide higher guaranteed benefits with little or no fees.
Variable annuity insurance companies assume a much larger risk than fixed annuity insurance companies when offering guaranteed benefits to their policy holders. A competitive insurance environment like we have today gives carriers even more reason to toe the line on offering variable annuity guaranteed living benefits that may be difficult to support during market downturns. Variable annuity insurance companies depend on the account value growing or at the very least maintaining its value. Major collapses in the markets can make these product offerings a significant liability for insurance carriers as we saw in 2008 and 2009.
See the article linked below for more information on how variable annuity insurance companies are cutting back on benefits and increasing fees.