Is there a silver lining in declining annuity sales?

Opinion

Like any company selling anything, insurance companies have to offer good value to thrive. Like any company selling anything, insurance companies have to offer good value to thrive.

Annuity sales have been declining and could remain depressed, partly because annuity shoppers aren’t being offered the kind of deals they got in the past. This obviously isn’t good for the insurance industry.

For consumers, however, a silver lining may be on the horizon. They may well get a better deal if interest rates increase just modestly, giving the insurance industry more wherewithal to offer more attractive products. Already there are scattered signs popping up of insurers offering annuities with better terms.

And if interest rates rise a bit and turn a few incidents into a trend, this is also likely to push the annuity industry out of its slump. You would normally expect annuity sales to be strong today because the giant baby boomer generation – the most affluent ever – is in or on the cusp of retirement and should naturally warm up to what has always been the biggest selling point of annuities – guaranteed income for life.

More attractive annuities

At some point, we will see more attractive annuities and a rebound in annuity sales. Before I elaborate on why this is likely, let me step back and explain how much annuity sales have been falling, why this is happening, why it could continue, and, ultimately, why a rebound nonetheless is likely on the strength of widespread unveiling of more attractive annuities.

Data from the Insured Retirement Institute (IRI), Morningstar Inc. and Beacon Research underscore the dip in sales of annuities.

According to the IRI, the leading association for the retirement industry, total annuity sales in the first quarter of 2015, the latest official figure available, reached $52.7 billion – down 6.9 percent from $56.6 billion in the previous quarter and 6 percent from $56.1 billion in the first quarter of 2014.

Annuity sales typically decline between the fourth quarter and the first quarter for seasonal reasons, but not year-over-year. Annuity sales in all of 2014 did rise 3.8 percent to $229.4 billion. That was a modest increase compared to earlier years, however. Sales in 2006 rose 10.3 percent, in 2007 8 percent and in 2008 4.6 percent, according to IRI data.

In addition, preliminary data from Morningstar Inc., a leading provider of independent investment research, shows that the downward trend apparently continues. Morningstar tracks sales only of variable annuities (VAs), the biggest sellers with 59 percent of the annuity market. VA sales fell 3.4 percent to $137.9 billion in 2014, and, in fact, have been declining every quarter since 2Q 2014.

Recent variable annuity sales data

Morningstar also has variable annuity data for the first two months of the second quarter, when they continued to decline. Sales in April declined 3.5 percent to $11.11 billion and by 4.6 percent to $10.6 billion in May, Morningstar figures show.

Over time, annuity sales have largely followed a see-saw pattern, impacted by shifting interest rates and a fluctuating stock market, IRI data show. But that pattern has been deteriorating. For example, 2012 was a particularly bad year, with sales declining 8.4 percent to $211.9 billion, according to IRI data.

Sales have improved but remain disappointing partly because interest rates, which strongly influence annuity sales, have been mired at record-low levels for years. The Federal Reserve is expected to begin increasing rates this year, but it has said increases would be mild. If rates rise negligibly, annuity sales will not rise much if the insurance industry retains the status quo. As it is, U.S. interest rates, as low as they are, are high by the standards of most industrialized nations, significantly trailing only rates in China, where they also are declining.

Higher rates require stronger economic growth, but that doesn’t seem to be in the cards. The U.S. economy grew at only a 1.5 percent annual rate in the first half of the year, well below the average pace of the six-year economic recovery. Other economies have been faring materially worse for years. Consider, for example, Japan, which still suffers from stagnant growth and deflation in the wake of the so-called “Lost Two Decades” from 1991 through 2010.

Sales also down because of insurance companies’ strategies

The point is that annuity sales have fallen largely because they naturally follow the direction of interest rates, and rates are way down. But another important factor is at work: Annuity sales have also fallen because of the way the insurance industry has reacted to low rates.

Consider, for example, variable annuities. As recently as the end of 2008, they typically paid about 6 percent annually. A year later, that fell to 5 percent, and today rates as low as 4 percent are dangled before potential customers. In addition, VAs today charge higher fees – typically a total of 3.5 percent annually, as much as 0.75 percent higher than before. And joint policies for married couples, which once paid the same as single policies, now pay about half a percentage point less.

Making matters worse yet, VAs today offer fewer and more conservative sub-account (mutual fund) options, which are cheaper to hedge.

The key question at this juncture is whether insurance companies are willing to make VAs and other annuities more attractive again. The answer, I believe, is yes.

If interest rates, now just above 2 percent, rise about a percentage point – a likely scenario at some point – insurance companies will introduce more attractive annuities. One company recently increased rates on a deferred income annuity. Another recently sweetened some provisions on a fixed indexed annuity.

Why insurance companies will act

One reason insurance companies will act is that they can afford to do so. They have culled many higher-cost annuities from their portfolios and have strong balance sheets. And, it is not as though they haven’t improved annuities before. When the stock market collapsed in 2008 and 2009, they dramatically improved terms on some annuities so they could attract fresh capital and maintain their industry ratings.

A second reason for action is that insurance companies may have to improve their annuities before long. Sales, after all, are falling, and many insurance companies are publicly traded. The market wants companies to grow, not shrink.

Consumers, of course, also have choices. People don’t have to own annuities to enjoy financial security in retirement. Most of the time, they can fare well by simply maintaining, say, a stock and bond fund portfolio weighted 60/40 stocks and bonds. According to Monte Carlo simulation research by T. Rowe Price, those who do so and annually withdraw a maximum of 4 percent of their portfolio have only a 6 percent chance of running out of money over 25 years.

Like any company selling anything, insurance companies have to offer good value to thrive. As interest rates start climbing, watch for them to roll out more attractive annuities.

See also:

U.S. fixed indexed annuity sales on growth course

Annuities critical in retirement planning

The top 5 fixed annuity benefits to discuss with clients

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