As Interest Rates Fall, Fixed Annuities Hit Highs And VA Fixed Accounts Rise

VA assets dropped 9% to $827 billion at year-end while fixed annuity assets grew a healthy 12% to $466 billion. Combined, annuity assets dropped 2% to end the year at $1.293 trillion, the third consecutive decline in assets.

Historically, interest rates and the equity markets have displayed an inverse relationship, with interest rates generally rising during market declines and vice versa. The proportion of fixed annuity sales to overall annuity sales has generally risen and fallen along with interest rates (see Figure 3 on page 38).

Beginning in 2000, this relationship changed as both stock prices and interest rates fell. While a drop in VA sales during a decline in stock prices should not be a surprise, fixed annuity sales have skyrocketed during a period of falling interest rates. Why would fixed sales increase while their interest rates (rate of return) decrease?

Market trends explain much of this. The second half of the 1990s saw dramatic increases in the equity markets, which enticed many individuals who previously did not invest in this market to begin to do so. Stock prices peaked in March 2000. Since then, they have posted three consecutive years of decline.

In such an environment, consumers viewed even the increasingly modest rates of return offered by fixed annuities as clearly favorable to the negative performance occurring in the equity markets. Hence, fixed annuities had record sales in each of the last three years.

An inverse relationship between equity markets and fixed annuity sales, as opposed to fixed interest rates, may be the result. If that were to be the case, then an upswing in the equity markets could sharply reduce fixed annuity sales as customers pursue the higher returns in the newly rising equity markets.

Another explanation for the increase in fixed annuity sales reflects changing demographics. Increasingly, buyers have purchased fixed annuities through banks and independent agent channels. A side-by-side comparison between fixed annuities and bank certificates of deposit has shown a more favorable rate for the fixed annuity. Also, an investment with a fixed rate of return is favorable, for suitability reasons, for older clients to whom independent agents, and banks in particular, often sell.

While every distribution channel posted gains in sales last year, banks showed the largest increase, followed by independent agents. These channels have long been the leading channels for fixed annuities. (Stockbrokers remained the largest overall channel, accounting for one-quarter of all annuity premiums in 2002.)

It is this confluence of factors that has enabled fixed annuities to drive overall annuity sales to record heights.

A relatively favorable rate of return along with an aging population with a need to manage their retirement assets have created an environment well suited to fixed annuity sales.

Eric T. Sondergeld, ASA, CFA, MAAA, is corporate vice president and director of the Retirement Research Center at LIMRA International, Windsor, Conn. His e-mail is [email protected]. Dan Q. Beatrice, ACS, AIAA, is a LIMRA analyst and his e-mail address is [email protected].

Reproduced from National Underwriter Edition, April 7, 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.