Navigating a Persistent Low Interest Environment
By Daniel H. KruseMr. Kruse is Second Vice President and Actuary, Individual Annuity Products, Securian Financial Group, Inc. He can be reached at [email protected]
With the consumer price index up only 2.9 percent in 2011, inflation still might seem hard to imagine. Even though the index rose .4 percent in February (translating into an annual rate of 4.8 percent) the Fed clearly believes it will be a while before the economy takes off.
Annuity manufacturers and consumers have become accustomed to this low interest rate environment. Annuity guarantees that clients found unacceptable a few years ago are now in demand. Individuals want security. When the market was at the height of its turmoil a few years ago, consumers viewed long-term guarantees from financially strong institutions as the safety they sought. Longer interest rate guarantees were possible with many fixed annuity contracts because of market value adjustment provisions that would recognize changes in interest rates if a contract owner chose to step out of the contract early.
Generally, market value adjustments result in an extra charge if interest rates rise after the contract is issued, or a contract credit if interest rates fall after the contract is issued, if funds are withdrawn or surrendered from the contract before the end of the guarantee term.
However, fixed annuities with market value adjustments have two key drawbacks that limit their desirability among consumers and advisors. The market value adjustment itself tends to be a complicated formula that contract owners cannot readily evaluate on their own. Also, a number of states require financial advisors to meet variable annuity licensing requirements to sell annuities with market value adjustments.
An annuity designed for the times
One way the industry might respond to these key marketplace drivers would be to create a product that preserves the longer-term interest guarantee capability without requiring the use of market value adjustments. This can be done primarily by not including a window at the end of the initial interest rate guarantee where surrender can occur without surrender charges, a feature common in market value adjusted contracts. Instead, the surrender charge remains in place for its full duration from the contract issue. The design meets the demand for greater simplicity and eliminates the need for advisors to be licensed to sell variable annuities in the states that require it also to sell market value adjusted annuities. This same shift to greater simplicity might also allow a company to offer greater choice in initial guarantee periods for the client.
The more relevant question might be, Why develop a new fixed annuity product now when interest rates are so low? There are two primary reasons. First, there continues to be a material market for fixed annuities. Consumers at various stages in their financial planning find value in the guaranteed interest rate and ability to turn accumulated value into guaranteed lifetime income at some future point. Second, insurance manufacturers saw first-hand in 2009 how economic changes can occur so quickly that not keeping the available product suite current can mean missing the opportunity. By the time some new products were through development and regulatory approval in 2009, interest rates had already declined and the significant flow of dollars into fixed annuities had eased back to previous levels.
When will the market shift?
Even experts vary widely on the critical indicators and timing of any material inflationary environment that could drive interest rates higher. While inflation obviously is a key economic factor, flat or falling interest rate scenarios continue to be relevant in risk positioning.
Every company in the industry now is carefully considering its annuity capacity and how much of the various associated risks they wish to carry on their balance sheets. Some companies are getting out of the annuity market altogether, with low interest rates and high equity market volatility being key economic risk drivers. Others are actively managing their capacity.
This shift in risk management in the annuity market doesn’t signal a softening of demand. Producers continue to demand competitive products. Consumers continue to demand safety that sometimes can only be met with insurance guarantees. Although it is not the environment that existed previously where each new feature had to outdo the last, it is still a feature-driven market. An insurer’s products cannot be very far from the competitive sweet spot to remain relevant Baby boomers accumulated wealth throughout their working years and are on the verge of turning it into income that lasts throughout retirement. As they near that transition, an enormous opportunity arises for financial advisors to support these clients with the tools and products they need to convert a lifetime of saving into financial security in retirement. The key for insurers who want to remain competitive in the annuity business is to maintain financial strength and develop products that will help those clients achieve their retirement income goals no matter how long they live or what turns the market takes.