Annuitization Rates Are Inching Up, But What Will Take Them Higher?
Although lifetime income is unique to annuities among financial products, this feature has not been widely utilized.
In 2000, just $4.2 billion of the $190.2 billion in annuity sales went towards the purchase of an immediate annuity and just 1% of deferred annuity assets were annuitized (see Figure 1).
However, interest in using annuities for income has increased considerably among industry players, as it becomes apparent that the demand for guaranteed income will increase in the years to come. This article explores the factors fueling that demand and then looks at some possible industry responses.
First, lets review todays annuitization landscape.
The rate of annuitization is higher for fixed deferred annuity assets (2.1%) than for variable annuity assets (0.6%). Demographics are probably the primary factor in this, as more fixed annuity owners are of an age where they might consider annuitizing. Fixed annuitization is also easier for
consumers to understand than variable annuitization.
This didnt discourage several annuity writers from developing new immediate variable annuities (IVAs) in the last few years. And although new product filings in this area have slowed significantly, likely as a result of the recent economic downturn, IVA sales did grow last year even as deferred VAs lost ground.
Going forward, many factors will impact the demand for guaranteed income:
Increasing numbers of retirees. While no reliable source on the number of retirees currently exists, the 65+ population serves as a proxy. This group numbers about 35 million today, representing nearly 13% of the population (see Figure 2). This decade, the group will increase by another 5 million.
The driving force: The real growth will occur in the following two to three decades, growing to 76 million strong by 2037, or over 20% of the population (see Figure 2).
Increasing life expectancies. We are all aware of the tremendous gains in life expectancy during the last century. The rate of increase is not predicted to maintain the pace set in the 20th century, but life expectancies will undoubtedly continue to grow.
There are two pitfalls in life expectancies that must be overcome. First, people retiring today tend to underestimate their own longevity, frequently basing it on that of their parents or grandparents. Second, advice on how to die broke is rampant and seldom mentions annuities.
The driving force: Public education about the dangers of planning for a specific time period, such as their life expectancy, will increase. This is especially necessary since life expectancy is a moving target (i.e., for a 65-year-old woman with a 20-year life expectancy, her life expectancy if she survives to age 85 is greater than zero).
Other sources of guaranteed income. Each year, more people retire with accumulated assets in defined contribution savings plans, and fewer with defined benefit plan income. In addition, defined benefit plans are increasingly offering lump sum benefits as an alternative to lifetime income; and many employers have converted their traditional defined benefit plans to cash balance plans (which, though technically defined benefit plans, look more like defined contribution plans).
The driving force: A growing number of people will retire without any source of guaranteed lifetime income other than Social Security. With confidence in the future of Social Security waning, many are assuming it wont be there for them.
How and when people retire. Other trends will greatly impact the timing and nature of retiree income needs. The median retirement age fell steadily from the 1950s to the early 1990s, before it leveled. Early evidence suggests this trend has now reversed itself.
The driving forces: Explanations for the delayed retirement trend include: increases in the Social Security normal retirement age; elimination of
Social Security work disincentives; and, in the short run, recent market losses that may cause some to delay retirement and still others to “unretire.” More importantly, the very nature of retirement is changing, as are retirement expectations.
Given todays lackluster immediate annuity sales and the above trends, the natural question is: What can industry players do to ignite annuitization activity? Here are some suggestions.
1) Focus on annuitization. All the attention on retirement savings coupled with strong equities markets in the 1990s led the industry to emphasize accumulation, so deferred annuity sales grew steadily. However, relatively few companies emphasized annuity income strategies. One leading fixed immediate annuity provider told me the company wasnt really doing anything to promote the product but wondered how much theyd sell if they simply tried.
2) Educate the public and the producers. Consumers, including many annuity owners, generally need to be educated about how annuities can help them create retirement income. This education should start early and be reinforced, since many (especially those in or near retirement) feel confused, even suspicious, when first hearing of the concept.
Here are three simple ideas to accomplish this: Consider updating product marketing materials to make this feature more prominent; modify customer statements to show how much income their annuity could create at a given age (or today for those already of retirement age); and include articles with customer newsletters or statement mailings explaining how the income feature works and can be used.
Many sales reps could use a refresher, too, including ideas on how to position the feature.
3) Compensate the producer. Commissions on annuitizations of deferred annuities are either small or non-existent, and immediate annuities generally pay lower commissions than deferred annuities. And the rep loses control over annuitized assets. Trailed commissions can help, as can paying the rep some type of advisory fee, particularly if he or she is helping to manage the asset allocation of a variable payout.
4) Keep up with product design, but dont over-emphasize it.The 1990s taught providers that innovative product design and competitive product portfolios were important to sales. As a result, many now believe that, with the right design, theyll sell lots of IVAs.
My take is slightly different. Product design is important. However, its importance should not be exaggerated. The fact that IVA offerings have not, to date, generated sales levels comparable to those for new deferred product introductions supports this. If the product is not emphasized and the distribution outlets are not excited about selling income products, it wont sell.
5) Adopt a consultative (vs. product sales) approach. Determining how to create income for the rest of ones life is, in my opinion, a much simpler equation to solve than choosing which vehicle in which to invest and save for retirement.
In short, annuity income cannot be sold in a vacuum. The individuals (or couples) entire retirement picture must be understood first. This includes considering both financial and non-financial issues. The financial issues include all the various risks retirees face (longevity, catastrophic health and long term care, mortality, inflation, investment, etc.) and their aspirations (travel, funding grandchildrens education, charitable giving, estate planning, etc.).
Although todays annuitization activity is lower than many would like it to be, the rate of annuitization increased in 2000, and income product sales have increased for nearly three years. Interest among industry players in finding ways to use their annuities for income is also on the rise.
These trends, as well as those cited above signal continued growth in annuitization. Finally, each additional company and sales rep that simply tries to do more will accelerate this growth.
Eric T. Sondergeld, ASA, CFA, MAAA, is corporate vice president and director of the Retirement Research Center at LIMRA International, Windsor, Conn. His email is email@example.com.
Reproduced from National Underwriter Life & Health/Financial Services Edition, February 4, 2002. Copyright 2002 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.