Unbundling Annuities: Customers Speak And Computers Cringe

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When Henry Ford applied mass production techniques to the fledgling automobile industry to make cars affordable to most workers, he was famous for saying his Model T came in any color the customer wanted, “as long as it’s black.” Ford was producing his cars the way that best fit the production techniques he had created. The customer could take or leave what he offered.

For a long time, the annuities industry operated on Henry Ford’s original precept. Everything necessary for the annuity was bundled together in one package and offered on a “take it or leave it” basis. And like Ford’s effort to increase efficiency in production, the annuity was bundled to fit the needs of the underwriting company.

We all know what happened to the automobile industry. It wasn’t long before basic black gave way to a rainbow of colors. And the Model T was joined by so many other models and styles and variations with options and accessories and customization plans that it is hard to imagine a time when anyone thought that one size would fit all.

Times have changed for the annuities industry, too. Today’s consumers are much more financially savvy than their parents, or even their older siblings. These consumers demand choice, in their cars and in their investments. To be successful in the modern annuities market, a company must offer a product with the flexibility to meet a wide variety of needs.

These market pressures are what led to the current practice of “unbundling” annuities. In the old days, the M&E charges (reimbursements to insurance companies to cover the estimated “mortality and expense” risk) represented expenses associated with the “standard” and fully loaded annuity and were deducted during the calculation of the fund’s unit value. Since the customer only saw the end resultthe unit valuethey rarely appreciated the magnitude of the M&E deduction.

But as consumers pushed for more specialization, the industry has responded (and rightly so) by pulling these and other charges out of the package and selling them individually, much like options in a car.

However, the automobile and annuity analogy breaks down at this point. Once an automobile buyer signs on the dotted line, the deal is done. Even if the purchase is financed over time with monthly payments, the car buyer can’t go back and undo parts of the deal. You can’t decide 12 months into your 48-month commitment that you don’t really need 14 cup holders and have them removed to lower your payments.

But with an annuity, the customers can change their minds about the “options” they want. And the fear is that customer will do just that if they know how much each of the “unbundled” charges cost them each month.

The securities industry addresses this challenge in a creative way. The charges are “unbundled” at the time of sale, and then essentially “rebundled” for the purposes of billing, with charges rolled back into the annuity through a recalculation of the unit value of the fund.

In theory, this solves the problem. The customers choose up front what they want based on cost and suitability to personal needs, then never have to worry about it again. All they see is the unit value on their statements.

But the law of unintended consequences has kicked in. By recalculating the unit value for each and every customer, a system that was designed to work at the fund level is now working at the consumer level. Instead of recalculating the unit value for a hundred or so different funds each night, some system operators are faced with literally thousands of calculations each night.

The systems weren’t designed for this kind of strain. In the immortal (and oft-uttered) words of Scotty the engineer on Star Trek, “She can’t take it, Captain. She’s gonna blow!”

To a certain extent, we systems people are victims of our own success. For years we have preached that the right information technology would solve the business problems of the moment. And, in our defense, for the most part we have delivered. Delivered so well, in fact, that now the insurance industry’s first solution to any business problem is to hand it over to the technology team to fix.

I may have to turn in my pocket protector for saying this, but an IT solution by itself may not always be the best solution, for the company or the customers. We may need to take a broader look at our industry in order to successfully navigate todays changing business climate.

Take the unbundling situation. Is there another way to achieve our goals beyond the recalculation solution that is already being employed? One thought that comes to mind is to show the costs associated with the selected benefits as a deduction to the customers account, just like annual maintenance charges.

This has two advantages:

First, by not including the M&E in the funds, the funds will show better performance, a significant benefit in these times of market uncertainty.

Second, the honesty involved would do a lot to enhance the reputation of the industry.

During a speech last year before the National Association for Variable Annuities Regulatory Affairs Conference, Paul Roye of the Securities and Exchange Commission put us all on notice that regulators and lawmakers are watching us.

“The future of your business lies in the trust of your customers,” Roye, director of the SECs Division of Investment Management, told the crowd. “In the coming months, you will see a continued focus on fees at the Commission and on Capitol Hill.”

Will our current practice of recalculation satisfy Roye and others that we are working to keep the trust of our customers? Can we run that risk? Or should we make some tactical shifts even if it involves some effort?

My point here is that systems are not the only thing that has to change if our industry is to thrive. The unbundling trend just provides the latest and most visible example of a challenge that needs the attention of every part of a company in order to be solved in the best way for the customers, the stockholders and the company.

is a senior partner with CAST Management Consultants, Los Angeles, who specializes in systems conversions. He can be reached at emiller@castconsultants.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, September 24, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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