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You might expect fixed annuity sales to have an inverse relationship with the S&P 500.

That is often the case, but usually fixed sales are tied more directly to interest rates. Lower rates, such as those that prevailed in 2003, generally depress sales of fixed annuities.

The effect is not always so simple, however. This article looks at fixed annuity sales specifics, with an eye to what lies ahead.

Fixed sales rose from 2001 through July 2002, even as rates declined. And, in 2003, the low interest rate environment tended to favor certain product types and rate terms over others. The reasons for this apparently related both to market demand and shifts in products offered by carriers.

It is not just the interest rate environment that affects fixed annuity sales. At least as important is the extent to which fixed annuity credited rates are higher than yields on other interest-bearing investment alternatives.

To illustrate, look at Chart 1. This shows a favorable interest rate spread for fixed annuities over 5-year Treasurys, beginning as early as July 2000. This spread set the stage for the massive surge in fixed sales that began in 2001. Sales rose despite declining rates, partly because the spread was favorable. Investors who were in a conservative mood found fixed annuities very attractive relative to the interest-bearing alternatives.

Conversely, the narrowing spread with Treasurys that began in June 2003 has been accompanied by a general decrease in fixed annuity sales. Spread relative to bank certificates of deposit is considered a particularly important driver of bank fixed annuity sales, for obvious reasons.

Higher interest rates tend to favor sale of market-value adjusted annuities over other fixed deferred product types. This is largely because the MVA policies pay what amounts to a bonus if the owner surrenders the contract when rates decline in the future. This pattern was born out in the “Beacon Research Fixed Annuity Premium Study,” which shows that participating carriers saw MVA sales increase 14% in 3rd quarter 2003, when rates were somewhat higher than the previous quarter.

But credited interest rates throughout 2003 were very low by historical standards. They actually declined 21 basis points from January to September. This had an impact on MVA sales by interest rate guarantee period, as can be seen in Chart 2. This chart shows a steady increase in sales of products with 10-year rate guarantees over the first three quarters of 2003, apparently at the expense of MVA fixed annuities with 5-year rate guarantees.

One would expect low interest rates to favor shorter interest rate periods, since investors presumably are reluctant to lock in low yields for long periods. Perhaps few were interested in credited rates as low as 3%. In addition, sales of products with 10-year rate guarantees were highest in the 3rd quarter, when yield curves began to steepen.

The shift in MVA sales by rate guarantee period also may have been affected by product availability. In 2003, carriers tended to pull from the market those products that had credited rate bands with shorter terms. They did this in reaction to the compression of spreads between credited rates and investment returns.

Simply put, many insurers–especially those offering products with shorter-term annuity rate periods–were unable to achieve profitability targets with minimum guaranteed interest rates of 3%. Some actually chose to reduce sales in order to attain profit objectives.

To the extent that availability affects sales by rate guarantee period, the industry may now start seeing a shift back to annuities with shorter-term interest rate periods. Throughout 2003, carriers pulled products and rate bands that had 3% minimum guarantees and then re-filed to add bands at lower guaranteed minimums. (See Chart 3.)

This trend is expected to continue, along with the low interest rate environment, well into 2004.

As carriers profitability on shorter-term annuity products improves, the industry may start to increase some commissions. Availability may increase as well. These trends should provide further stimulus to fixed annuity sales.

is president of Beacon Research, Evanston, Ill. His e-mail address is jeremy@beaconresearch.net.


Reproduced from National Underwriter Life & Health/Financial Services Edition, February 13, 2004. Copyright 2004 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.