The problem of annuity persistency seems to be growing, not shrinking. Over the past few years, most insurance carriers have expressed disappointment with annuity lapses that are well in excess of their original pricing models. These surrenders have a huge impact on profitability and ultimately impact the carriers’ appetite for new annuity business as well.
Carrier responses have ranged from do-nothing to aggressive conservation and replacement programs. Do-nothing carriers are certainly a shrinking universe. Most companies are at least trying to save large policies that are on their way out. But this is still largely a reactive mode and not terribly productive.
Before I go too much farther, it probably makes sense to define some terms and provide some history.
All deferred annuities (both fixed and variable) are priced with an expected lapse pattern. In other words, there is some expectation that the annuity owners will voluntarily withdraw some or all of their assets over the years. Lapses also happen due to an owners death, but well ignore that here, because it doesnt represent a voluntary withdrawal.
Partial withdrawals are also a form of lapse, but since they typically dont represent huge problems, and typically are taxable, we will ignore those for this discussion as well.
Its worth noting that both deaths and partial withdrawals can represent significant problems for insurers if they are not priced properly, but these problems are typically orders-of-magnitude smaller than total lapses.
By far, the biggest problem insurers face are total withdrawals (also called lapses or surrenders) done via Section 1035 exchanges. A 1035 exchange affords the owner the ability to maintain tax deferral as he moves from one insurer to another. The worst problem usually occurs in the year following the end of the surrender charges. This is known as the shock lapse. The owner feels “free” to move as he wishes or is advised, and agents feel “free” to find a better deal for their clients and often a new commission.
The pricing/profit problem comes from the fact that the actual lapse level is in excess of the expected lapse level. Ive seen recent situations where actual lapses have exceeded expected lapses by 4 or 5 times. This can take an otherwise profitable block of annuity business and turn it into a true disaster. Some carriers have been forced into $10′s of millions or even $100s of millions in write-offs due to this problem over the past few years.
Now that we understand the problem, what can be done about it? Actually quite a bit.
First, insurers need to recognize the problem and commit resources to solving it. Just as there is a team dedicated to new business (sales) there should also be a team dedicated to conservation. This team neednt be large, but it should be dedicated and committed. It should also include at least one member from the top management of the company.
Now Im going to deviate from the conventional wisdom of conservation. The conventional wisdom of conservation tells you to begin your conservation activities either at shock-lapse time or shortly before. I believe conservation starts before you even sell the policy. In fact, it starts with the selection of your distributors and the product you design for that distribution.
Lets start with a look at distribution. There have been a few studies done over the years that have tried to discern lapse pattern differences from among a multitude of distribution systems. My opinion of these studies is that they are inconclusive and possibly misleading.
The studies typically look at a small group of policies, often from only one insurer. Product types as well are segmented only in vague and broad categories. This means that not enough detail is used on product type and not enough companies and distributors are used.
The result is that the information gleaned is too specific to be of help in looking at broad questions about which distribution system provides better annuity persistency. The studies can tell you a little bit about the actual distribution evaluated, which I think is most helpful, but not much about the distribution system.
All of this goes to my opinion of what constitutes good distribution. The vast majority of banks, brokerage general agencies, managing general agencies, wirehouses, broker dealers and marketing organizations have been in the annuity business long enough to have established persistency patterns. Insurers should get this information, whenever available, to determine the right fit.
In my experience, Ive seen good and bad partners in every distribution system. As a distributor dont be shy about touting your success to future insurance partners.
As a carrier, once your distributors are chosen, its now time to select the right product(s). Your distributors will be of tremendous help here. (Always beware of those who put commission above everything else.)
The goals of the product, communication package, and commission structure should be to treat the customer fairly, compensate the producer fairly, and establish an ongoing commission link with you, the agent, and the customer.
Theres no question that ongoing work and communication are required, both from the carrier and the agent. If you make sure that work is well defined, well communicated and well compensated, you minimize lapse risk. Additionally, if the product performs as expected, this also maximizes persistency.
I dont want to leave anyone with the impression that all of this is easy to do. Identifying the right producers and building the right product with the right company is hard work. You need to rely on experienced experts to help. Many producers are very reluctant to give up any up-front commission for asset trails, even if you can demonstrate that they will make even more money. This is changing, however, as todays realities become evident.
In my next article, Ill continue this topic by looking at ways to increase persistency once youve sold the product.
Thomas F. Streiff, CFP, CLU, ChFC, CFS,
is president of IAC Securities, Inc., Member NASD, SIPC
and Money Matters Exchange, Inc., Chicago.
Reproduced from National Underwriter Life & Health/Financial Services Edition, December 10, 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.