How advisors will be affected by emerging industry trends
by John McCarthyMr. McCarthy is Product Manager, Insurance Solutions, Morningstar, Inc. He can be reached at [email protected].
Financial advisors have a host of new variable annuity features to look at as they consider which products fit inside a retirement income plan. Insurers have a number of challenges right now that make offering annuities more difficult than in the past. At Morningstar, we track the industry from a number of angles. Here are several trends we’ve spotted that could impact your business.
Trend: Consolidation Among Variable Annuity Carriers
Despite the rise in variable annuity sales for the third straight year, the Big Three carriers (MetLife, Prudential and Jackson National) have garnered an increasing share of the pie. A number of previously formidable carriers have shifted their focus. Hartford, a $9 billion per year VA sales juggernaut ten years ago, experienced a 90% sales decline over the same period, and recently exited the business. John Hancock pared back distribution. The year before two other carriers said goodbye to VAs. The big three carriers now account for 47% of current sales, compared to xx% in 200x. There looks to be no reason this trend would slow down.
What are the benefits of consolidation? Well, fewer carriers mean potentially fewer products to have to worry about. Since every carrier does things a little differently, there may be fewer exceptions for reps to juggle when it comes to product features, contract titling, and processing. On the other hand, fewer carriers mean less competition, and potentially less attractive features for clients.
U.S Variable Annuity Sales (in $Billions)
Annuity sales have risen for three straight years. Low interest rates pose challenges for insurers. Source: Morningstar Inc. 2012.
Trend: Product Guarantees Moving from Fixed to Variable
Product innovation continues at a rapid pace (see chart). Carriers are increasingly converting to variable pricing and features within living benefits. What this means is that instead of offering a firm guarantee of, say, 5% withdrawals for life, the carrier makes the guaranteed rate dependent on a metric that fluctuates. This results in a guaranteed product with a floating guarantee. For example, the lifetime guarantee becomes ‘lifetime withdrawals between 4% and 8%, depending on the current rate of the 10-year U.S. Treasury note.’
One lifetime guaranteed minimum withdrawal benefit ties its withdrawal percentage to the U.S. Treasury rate. Withdrawals start at 4% and increase to as much as 8%, but the actual percentage depends on the level of the treasury rate.
In addition, one firm is tying the annual step up to the U.S. Treasury rate as well. In this case, the carrier bumps up the benefit base by a percentage each year, but the rate is driven, again, by the 10-year U.S. Treasury rate.
In some cases, the calculation of fees is following the same path. One firm links the benefit fee on its withdrawal benefit to a volatility index. If the volatility index goes up, the fees go up, based on the fact that it costs more to hedge in a volatile environment.
Many of these product structures fit into an overall trend to push risk back to investors. Based on the above developments, carriers can take on less risk. In addition, the carriers are limiting the number of subaccounts that can be invested in, which allows them to project guarantees inside a narrower band of performance and allowing them to hedge more effectively.
VA Product Changes in 2011
Insurers continue to adapt their VA products, filing over 380 product changes during 2011. Many of the product changes were a reaction to low interest rates, recovering equity markets, or a longer-term focus on innovation.
Trend: New Pricing Structures
The newly created O-share contract combines the sales charges of the A-share with the surrender schedule of a B-share. The sales charges gradually reduce over the surrender term, until they disappear entirely when the surrender period ends (generally 7 years). The share structure is logical, as the variable annuity is a long-term investment, and the O-share pricing benefits the investor who stays invested in the product. As of Dec. 31st, 2011, seven carriers had rolled out O-share products.
Fee based I-shares are increasing in popularity. This price structure is designed for two markets: the direct sold channel and the RIA channel. I-share contracts released this year are up over last year.
Finally, in a return to the past, insurers are increasingly providing bare-bones contracts that offer nothing but tax deferral. Prices are low, investment options are many, and tax-deferral is the selling point.
Trend: Low Interest Rate Challenges
It has never been tougher for carriers to make a buck in the annuity industry. Margins are extremely thin. The guarantees already on the books serve as a ball and chain to profitability. Hedging the risk of these guarantees is costly, especially when volatility is high. Carriers have responded by pulling the three main product levers: fees, withdrawal percentages, and step ups. Behind the scenes they are hedging their bets. In addition, carriers have continued to limit the number of subaccounts that can be invested in. All this is an attempt to do the rope-a-dope until interest rates return to more reasonable levels.
While much of the product development helps carriers manage risk, it also has the unintended consequence of making things much more confusing for advisors and clients. The single most complex benefit that our Morningstar research team analyzed (a long-term care rider) was released this year, and set a new mark for complexity. We do our best all the time to translate complex annuity provisions into plain-English. But the environment is conspiring to push up the level of complexity, making it even more critical for reps to keep up to speed on product design and use. Even the easy parts of the annuity, the subaccount options, are getting more complex. Alternative investment strategies in subaccounts are increasingly popular, and those investments cover a myriad of tactics and strategies that can be difficult to understand.
Notable New Product Development in the Retirement Space
Insurers continue to innovate to capture the attention of advisors and their retiree clients. These four areas will be the ones to watch in the coming months.
- Longevity Insurance- proposed regulations potentially affect success
- Deferred income annuities (DIAs)- explosive growth over past year
- Standalone Living Benefits (SALB)- new, innovative, untested
- Alternative Strategy Subaccounts- not all are created equal
The current crop of innovations is helping carriers cope with low-interest rates, but making it harder for advisors to understand annuities. The latest industry efforts have helped maintain sales and provide a source of guaranteed income for investors. But carriers have yet to ‘crack the code’ on how to make variable annuities, longevity insurance, and standalone benefits the centerpiece of the retirement income product mix. Efforts continue to make annuities a more appealing option for fee-based advisors. Fixed index annuities may emerge as a nice ‘middle ground,’ they provide exposure to an equity upside but eliminate the equity downside.