From the July 2014 issue of Investment Advisor • Subscribe!

Assessing the Annuity Landscape

Variable annuities are getting more complex, while fixed annuity sales are soaring

Despite use of certain annuities dropping off, some sales predictions are soaring. Despite use of certain annuities dropping off, some sales predictions are soaring.

Annuities: Some advisors swear by them while others steer clear of them. Recent statistics reveal that while variable annuity sales have slowed, advisors still use them, and other annuity products—including new iterations of them—are gaining steam. What's more, on the horizon is legislation that, if passed, could boost advisors’ and broker-dealers’ willingness to sell annuities.

The Financial Planning Association recently polled 288 advisors of various backgrounds on their investment products use and found that while more than 79% of advisors are using and recommending ETFs today versus 40% in 2006, and that 39% of advisors plan to increase their use of ETFs over the next 12 months, only 41% of advisors currently use or recommend variable annuities, compared with a high of 58% in both 2006 and 2008.

The FPA study also found that 29% of planners surveyed say they are currently using or recommending fixed annuities for clients, down from a high of 49% in 2010.

But then we see these recent spectacular sales projections by Cerulli Associates: Variable annuity net new sales will reach $22 billion by 2018, a 57% increase from 2012 levels.

The Insured Retirement Institute also announced in mid-June the final first-quarter 2014 sales results for the U.S. annuity industry, based on data reported by Beacon Research and Morningstar, and found that industry-wide annuity sales during the first quarter reached $56.1 billion, up 13.1% compared with the first quarter of 2013 when sales totaled $49.6 billion.

Where was the biggest growth? Year-over-year sales growth was supported by continued high levels of fixed annuity sales, which totaled $22.6 billion during the first quarter, Beacon Research found. This was a 50.7% increase from nearly $15 billion in first-quarter 2013 and down just 4.1% from $23.5 billion in the previous quarter.

Meanwhile, according to Morningstar, variable annuity total sales came in at $33.5 billion in the first quarter, down 3.2% compared with first-quarter 2013 total sales of $34.6 billion and down 6.4% from $35.8 billion during the fourth quarter of 2013.

On a recent webcast to discuss VA market trends, Kevin Loffredi, a vice president at Morningstar, said that VAs “are getting more and more complex,” including insurance carriers putting in more details on how VA holders “actually get to exercise the [products’] living benefits.” Insurers have made VAs “complex, and that scares reps and advisors away,” Loffredi said.

But while VA sales may be down, IRI's 2013 survey of advisors found that nine out of 10 (87%) financial professionals sold a variable annuity in the past year, and that three-quarters of advisors report that their clients are receptive to annuities.

Clients’ attraction to annuities is accounted for by product features including guaranteed income in retirement (90%) and principle protection (84%), IRI said.

Indeed, a report released by the LIMRA Secure Retirement Institute found that retirees who own annuities had more confidence about living comfortably in retirement than non-owners. When asked about their confidence in living a “desired retirement lifestyle,” 47% of retirees and pre-retirees who own annuities said annuity ownership contributed to their feeling of confidence.

Morningstar's Loffredi noted on the webcast that interest rates play a “huge” role in what “goes on inside a variable annuity.” IRI noted in its state of the industry report, released at the end of 2013, that rising interest rates during most of 2013 had a positive impact on the insured retirement income industry. Among some of the benefits, costs decreased for hedging living benefits, reserve requirements for living benefits decreased, and immediate and deferred income annuities offered higher payout rates—meaning consumers received more retirement income.

IRI noted in the same report that interest rate levels and the direction of the rate changes affect the cost and benefit of annuities. The 10-year constant Treasury maturity rate, a rate used as a reference in pricing debt securities issued, increased in 2013, IRI said.

Rising rates contributed to higher fixed annuity sales as:

  • Payout amounts increased on immediate and deferred income annuities.

  • Fixed deferred annuities offered higher crediting rates.

  • Fixed indexed annuity caps and participation rates increased.

Interest rates also impact variable annuities. “Everything else being equal, rising interest rates generally lead to lower hedging costs and lower reserve requirements,” IRI said. “This may provide carriers the flexibility to increase their variable annuity business and to stabilize fees.”

While some carriers have stopped offering death benefits, Morningstar reported that 74.5% of VAs still include them. New annuity products without death benefits are designed for clients who are less interested in guarantees and more interested in tax deferral, asset class diversification including the use of alternative investments, and greater investment options, according to IRI.

It's also important to note that the number of FINRA arbitration cases regarding variable annuities has been dropping. While there were 274 such cases in 2010, there were 212 in 2011 and 174 last year.

As to product innovation, IRI noted in its report that a “turning point” occurred in 2013 for annuity product development with the expansion of several product types.

IRI projected that deferred income annuity (DIA) sales were likely to exceed $2 billion in 2013, a doubling of sales over the previous year.

On the legislative front, IRI is closely watching the National Association of Registered Agents and Brokers Reform Act (NARAB II), which would establish a one-stop, national licensing clearinghouse for financial professionals holding state insurance licenses in multiple states.

IRI said that its research shows that NARAB II's passage would remove a barrier that is impeding broker-dealers’ ability and financial advisors’ willingness to sell annuities.

Lee Covington, IRI's senior vice president and general counsel, said “there has been unprecedented momentum during this Congress to move NARAB II forward.”

The Senate passed NARAB II legislation as part of a flood insurance bill in late January, Covington said, and the House passed stand-alone NARAB II legislation last September, but acted on its own version of a flood bill.

“Policymakers on Capitol Hill clearly see the benefit of streamlined and cost-effective insurance licensing across state lines,” Covington said. “Now the challenge is to find the right legislative vehicle to ensure its passage through Congress.”

Covington added that there may be an opening on the “near-term horizon” as Congress must reauthorize the terrorism risk insurance program. “Whether it is through this legislation or some other bill, we will continue to work with congressional leaders to pursue NARAB II and its promise of efficient insurance licensing for financial professionals operating in multiple states.”

Editor's Note: Since this article went to press, the House Financial Services Committee approved on June 20 an amendment adding NARAB II to the Terrorism Risk Insurance Reform Act of 2014 (H.R. 4871). The amendment was offered by Rep. Randy Neugebauer, R-Texas, and was approved by voice vote. The committee voted 32-27 to report the bill to the full House.

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