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VA Products Clawed By The Bear

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The end of 2002 marked the longest consecutive bear market since 1941.

For the third year in a row, the major market indices posted losses for the year, as the Dow Jones Industrial Average, S&P 500 and NASDAQ lost -16.8%, -23.4%, and -31.5%, respectively. For variable product issuers already reeling from historic losses in fee-based income, the specter of a new year plagued with war and an uncertain economic picture did not give rise to celebration.

While variable life and the overwhelming majority of equity-based product sales declined in 2002, new VA sales posted a 4.1% increase over 2001 to $111.1 billion. Total sales (includes internal exchanges) for the same period rose .62% to $113.7 billion. This positive performance is a credit to the insurance features of the product, most notably guaranteed death, income and withdrawal options.

Despite the current risk-management difficulties the VA industry is facing, the role that this product will play going forward to insure individuals a secure retirement will all but assure its place at the retirement planning table.

Market losses continued to erode variable annuity industry assets, which closed 2002 at $788.9 billion, down -10.9% from year-end 2001.

Equity-based assets ended the year at 48.4% of total industry VA assets, with fixed/bond assets holding a 10.3% share. Money market assets and balanced/asset allocation assets remained small at a 4.9% and 7.5% share, respectively. General interest account (GIA) assets remained close to all-time highs with a share of total industry assets of 28.9%. As a point of comparison, over the past decade GIA assets market share has been as low as 18.8% in 2000 and as high as 34.7% in 1995.

For the Top 25 VA issuers ranked by assets under management, only three firms posted a positive increase in 2002 assets. Ranked in order of assets under management, they include Aegon/Transamerica with a 4% change, Pacific Life with a 0.69% change and Jackson National Life with a 7% change. For the balance of the Top 25, percentage change losses from the previous year ranged from a high of -21.2% to a low of -2.1%. There was virtually no change in 2002 market share from the previous year for the Top 10 and Top 25 VA issuers. They continue to control 69.1% and 92.4% of total VA industry assets under management.

In the category of Top 25 VA issuers ranked by new sales, 52% posted 2002 annuity sales which equaled or exceeded previous year sales, while the balance (48%) posted sales which were below. Three issuers posted a 2002 sales ratio of greater than 150%. Ranked in descending order, these firms include Aegon/Transamerica (205.7%), Jackson National Life (184.4%) and Allianz Life (343.2%). The individual contracts which contributed to the strong performance last year of these issuers are a testament to the guaranteed insurance features driving consumer interest in VA products.

The Top 10 VA issuers control 62% of last years total industry new sales, while the Top 25 control 92%. As compared to the previous year, the market share for the Top 10 rose by a significant 4%, while the share for the Top 25 remained virtually the same.

There was no lack of volatility in the Top 25 VA contracts in 2002. Four contracts were brand new, and six moved up in rank by more than 10 places. Leading issuer Aegon/Transamericas Landmark VA alone contributed to 37% of the issuers total 2002 sales volume and ranked 3rd in the Top 25, moving from 50th place in 2001. Landmark is a B-share product with a guaranteed minimum income benefit option and is coupled to 53 investment options. Hartfords Director Outlook moved to 6th place this year from 22nd in 2001. The L-share product is primarily sold through the bank channel and has 29 investment options and a guaranteed minimum withdrawal benefit. Manulifes Venture III contract moved to 13th from 110th. Venture III is also an L-share contract, with 61 investment options, and has an optional guaranteed minimum income benefit.

A new entrant to the Top 25 for 2002 is American Skandias XTra Credit SIX B-share, which is a bonus product coupled to a principal protection program with 87 investment options. Equitables new Accumulator Plus 2002 B-share product ranked 18th in new sales. The contract has 44 investment options, with a principal protection plan and an optional GMIB feature. The Jackson National Life Perspective II Fixed and VA contract is new in 2002 and ranked 20th. It is a B-share contract with 53 investment options, has an optional purchase payment bonus, principal protection benefit, and an optional GMIB. Allianz Lifes USAllianz Alterity contract moved from 122nd in 2001 to 21st last year. It is an L-share contract sporting 52 investment options, with an optional GMIB program. The Phoenix Retirement Planners Edge ranked 22nd last year, moving from 66th in 2001. The contract is a C-share product (one of two in the Top 25) with 55 investment options and a GMIB feature.

The Equitable Accumulator 2002 placed 25th in the Top 25 VA contracts and is a B-share product with 44 investment options. The contract has a principal protection program and an optional GMIB. Please note that we have not annotated optional death benefit features that these contracts may have due to space limitations. For example, the Jackson National Perspective II contract has seven optional death benefit options.

While the Top 25 VA contracts are still predominately B-share products, the growth of C- and L-share products over the past two years has been quite noticeable. For example, in 2000, 87% of the retail non-group VA contracts were B-share, while C-share comprised 10.5% and L-shares held only 1.7%. A-shares comprised less than 1% of the total retail non-group open contracts in 2000. In 2001, the comparative breakout by contract share type in order of B, C, L, and A was 78.9%, 13.7%, 6.2%, and 1.2%, respectively. In 2002, the pace of growth of L-share contracts surpassed that of C-shares, and today is showing signs of being the preferred new pricing entrant to the mix. As of the end of last year, the comparative breakout by B, C, L, and A was 67.1%, 16.6%, 15.0%, and 1.2%, respectively.

An examination of VA industry assets by retail non-group contracts reveals that while B-share products have declined over the past two years as a percentage of all retail contracts (from 87% to 67%), their net assets have declined by a smaller margin (from 90.7% to 85.9%) of total net assets for retail non-group products. C-share product assets have grown for the period of 2000-2002, from 6.7% of total retail non-group contracts to 8.8%. Over the same period, L-share contract assets have grown from 2.3% to 4.7%. A-share contract growth has hardly changed during the period 2000-2002, growing from 0.3% to 0.6%.

There was very little change in 2002 from the previous years industry VA sales by distribution channel breakout. Captive agency sales remained the largest sales channel at 35% of the total, down just 1% from 2001.

The next largest sales channel, that of independent NASD firms, gained 2% from the previous year, settling in at a 2002 share of 26%. New York wirehouses lost 1% last year for a 13% share, while regional investment firms stayed static at 13%. In the categories of bank/credit unions and direct response, both channels share in 2002 did not change from the previous year, coming in at 11% and 2%, respectively.

The year 2002 marked what many industry observers feel was a crossroad and a marked contrast to the heydays of strong asset growth for the period 1989-1999. In 2002 issuer downgrades increased fourfold, and there was a noticeable rise in feature stories on the financial woes of the current state of VA products. The sharp rise in rating agency activity last year prompted closer scrutiny of the financial and risk-management side of VA products, as Moodys Investors Service, New York, wrote in a special report that “it is highly unlikely that recently sold VAs will ever meet profitability targets.”

Increased concerns over adequate financial reserves to cover the risk of the new feature-laden products prompted the National Association of Insurance Commissioners, Kansas City, Mo., to promulgate a series of new actuarial guidelines for living benefits.

While some companies began write-downs to cover their death benefit exposure, it is expected that more will do so this year, especially if equities cannot achieve sustained positive growth. Many insurance analysts expect that the Financial Accounting Standards Board will force more issuers to take write-downs to their bottom line for their guaranteed minimum death benefit exposure. Additionally, increasing concern over exactly how much exposure issuers do have is growing, as distributors and their clients have found it nearly impossible to accurately quantify exposure due to a lack of required disclosure and a standardized accounting methodology.

Adding to the misery, the reinsurance market has all but dried up, forcing issuers to substantially increase the amount they will have to reserve and severely limiting the opportunity for new players to enter the marketplace. French insurer AXA, Paris, began this year with a shutdown of their U.S. reinsurance operations.

In 2002 VA underwriters Allmerica and Conseco, Carmel, Ind., left the ranks of VA issuers, and the sale of troubled firms like American Skandia to Prudential Financial, Newark, N.J., continued to make headlines as we entered the new year.

While the severity of the financial risks to VA issuers continues to unfold as we work through early 2003, numerous issuers have begun increasing the costs of selected guaranteed features such as income benefits, while others have ceased offering some of the features.

The financial impact of the risk-management issues has yet to be effectively measured, and the old adage that “bigger may not be better, but it may be safer,” should be of particular benefit to the larger multi-line carriers who are well-positioned to weather the current economic storms.

As we look to the horizon and the future of the VA product line, we can clearly see that the financial dynamics of an aging population, combined with the three-year bear market in equities, has quickened the pace and focus on retirement income planning.

At the recent NAVA Marketing Conference in Orlando, numerous keynote speakers echoed evidence of a movement to redefine retirement planning in terms of retirement income management (RIM). Such a program recognizes the need for a holistic approach to the planning process, which incorporates the optimal mix of products from Long Term Care insurance to annuities, coupled with “best practice” analytical tools.

A new Monte Carlo simulation tool that quantifies the optimal mix of annuitized and non-annuitized assets, incorporating both financial market and longevity risk, was unveiled by Ibbotson Associates. Current volatility in the capital markets, coupled with steadily increasing life expectancies, make inclusion of these risk factors crucial in the decision-making process. Typically, retirement planning calculations use age 85 as the mortality benchmark. Yet the probability that a person age 65 will survive past age 85 is over 50% for female and over 40% for male; the probability that one member of a couple age 65 will still be alive at age 85 is over 70% (Society of Actuaries 1996 U.S. Annuity 2000 Table).

Best practice analytical tools and new studies scheduled to be released this year should continue to validate the attractiveness of the insurance features available in fixed and variable annuitization. While the tax-deferred accumulation features of annuities have traditionally been the focal point of the product line, the inevitable shift in focus to the payout side appears to be gaining sustained momentum. A growing number of issuers are working on new income product designs which are also scheduled for release this year.

In closing, we reiterate that while the variable products industry does face significant challenges, a viable product line with features only the insurance industry can provide does portend a bright future for the coming 10 to 15 years.

is editor of the VARDS Report, a Roswell, Ga., publisher of annuity statistics, and managing director, professional services, for Info-One.

Reproduced from National Underwriter Edition, February 24, 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.