Dealing With The Current Instability In The VA Industry
By Norse N. Blazzard, and Judith A. Hasenauer
Much has been written in recent months about the current instability in the variable annuity industry. Numerous VA insurers have had their ratings downgraded and others have been sold under severe financial pressure. Still others have ceased new sales of VA products.
The reason for these problems has little to do with the basic structure of VAs themselves since in their purest form, the products cause little risk to the insurers that issue them. This is because the basic feature of a VA is the transfer of the investment risk from the insurer to the contract owner.
Instead, the instability problems result primarily from product features that have been added on to basic VAs to make them appear more competitive or to help differentiate products among insurers. In many instances, these add-on features were not properly priced, but were offered in an attempt to maintain existing market share or to increase market share in the highly competitive VA climate.
Many of these product features were added at the insistence of marketing firms that distribute large volumes of VAs. The additions have caused a significant investment risk to be reassumed by the insurer.
Probably the single product feature that has most contributed to the instability in the annuity industry has been “enhanced” minimum death benefits. These enhanced product features have taken many forms that differ markedly from the traditional minimum death benefits that have been integral to VAs since the early 1960s.
Instead of offering a death benefit that guaranteed a return of principal if the contract owner died before the annuity starting date, these “enhanced” features provide for numerous types of step-ups in contract values on the death of the owner, regardless of market conditions.
It seems that many insurers, secure in their belief that the halcyon days of stock market expansion would continue indefinitely into the future, failed to consider the impact an extended down market could have on their product lines and on their companies.
Agents, brokers and banks that sell VAs have compounded this problem. These distributors have insisted on increasingly “sweetened” product features without corresponding increases in product prices. This attitude reflects a basic flaw in the annuity sales process–i.e., sales by people who have not analyzed the financial basis of the products they sell or who mistakenly believe that any problems are only those of the insurers offering the products.
We have had marketing organizations tell us that they were not interested in whether a VA was financially sound from the insurers point of view. They said it is not their concern whether the insurer makes or loses money on the products the marketers sell for the companies!
We should remember the old adage that “he who does not study history is doomed to repeat it.”
The past 20 years have seen several insolvencies of insurers where consumers have sued the distribution organizations that sold the insurers products. The lawsuits contended the distributors should not have sold products they should have known were improvident.
In short, if consumers suffer, everyone involved in the product will be held accountable. The deeper the pockets, the greater the potential liability.
This is not to imply that we think a significant number of VA insurers are likely to become insolvent in the immediate future. The bulk of the financial problems at the present time are accounting problems, not cash problems. Contract owners with minimum death benefits must still die before an insurer is liable.
Nevertheless, we think VA distributors should take caution before they embark on any sales practices or exchanges of existing VA contracts that are likely to increase the instability of the insurers with which they do business.
VA insurers do not have a bottomless pit of money. They must have products and business relationships that can sustain themselves financially for the long term. If distributors take undue advantage of insurers by manipulating the products or the sales process to make the products unprofitable, then it will adversely affect the entire industry, not merely the insurers.
We believe everyone in a good business relationship must reasonably expect to profit from that relationship. Business deals that are one-sided or where there is no ability for everyone to profit will undoubtedly fail. It is necessary to analyze business relationships to understand their financial basis and to ensure that the financial basis for all parties is sound. Otherwise, the deal will fail and everyone will suffer.
Eventually, the current downturn in the stock market will end. VAs based on equities will, once again, be the ideal investment to help people plan for and secure their futures and retirements. Hopefully, the entire industry will have learned from its history and will undertake to develop and sell only those products that have a sound financial basis that will endure regardless of economic or market conditions.
Norse N. Blazzard, JD, CLU, and Judith A. Hasenauer, JD, CLU, are attorneys in the Ft. Lauderdale office of Blazzard, Grodd & Hasenauer, P.C. E-mail them at: firstname.lastname@example.org.
Reproduced from National Underwriter Edition, February 3, 2003. Copyright 2003 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.