New Annuity Designs Are Taking A Page From History

The sentiment behind a well-known Broadway musical, “Everything Old is New Again,” also could be applied to todays annuity business.

As insurers struggle to compete against other life carriers, the interest rate environment, equity market volatility and expense challenges, manufacturers are beginning to dust off past design concepts.

In all likelihood, the annuity market will start to see a return of some of these older structures or features. These will be the features that can improve competitive positioning. Here are a few examples:

Bailout provisions. These provisions enable fixed annuity policy owners to surrender their contracts without surrender penalties if the annuitys credited interest rates drop below a specified threshold.

Over the past few years, popular fixed annuities have offered multi-year credited interest rate guaranteeswithout bailouts. But, roughly 6 to 9 months ago, the trend shifted.

Noting that policyholders did not want to lock in relatively low market rates for several years, annuity marketers began moving back toward one-year interest rate guarantees.

The bailout feature could give these more recent designs greater competitiveness. For example, by coupling the one-year rate guarantee with a bailout provision at the initial credited rate, the insurer can strengthen the total package. The result would be a pseudo-multiple year rate guarantee, without adverse formula reserve requirements.

Bailout provisions also may be offered as a form of less expensive quasi-guaranteed living benefit on variable annuities. This would allow a policyholder the ability to surrender without penalty if future subaccount performance is poor.

Due-premium contracts. In the early days of deferred annuities, many contracts were designed as fixed premium policies. Policyholders were billed a due premium. If the premium was not paid, the contract could either lapse or lose certain benefits.

As the annuity market evolved, annuities became more single premium and flexible premium in nature. However, both single- and flexible-premium designs can generate more anti-selective interest rate, equity market or persistency risks.

By contrast, fixed, due-premium contracts can mitigate interest rate and equity market risks to the insurer. They do this by smoothing out market performance cycles and reducing tail risks under some contracts.

This ultimately can benefit the end customer–through lower benefit costs (e.g., for variable annuity guaranteed benefits) or higher credited interest rates. Such disciplined contributions also can create a strong accumulation amount for the policy owners retirement.

Two-tiered annuities. The two-tiered annuity pays a higher interest rate to the annuity account value that is used to determine annuitization (or payout) value than to the account value that is used to determine surrender value.

In past years, the more attractive annuitization value was intended to encourage annuitization. It also was seen as a way to reflect better the equity between different cohorts of customers.

However, concerns arose over the ways that some two-tier products were sold and disclosed and over the magnitude of the differential between the two account values.

Recently, though, annuity insurers have begun to revisit two-tier design features that could encourage long duration annuitizations. See the chart on this page for examples of such features.

Insurance feel. In the early days of annuities in the United States, the product had a greater “insurance feel” to it and was sometimes paired with other insurance coverage through the use of riders, etc.

In recent history, though, annuity designs focused more on pure accumulation/retirement savings aspects of the contracts. This, too, is gradually being revisited.

Today, annuities are being re-tooled to take advantage of their flexibility in incorporating other components of insurance features. Examples include benefit guarantees, supplemental death benefits, accidental death benefits, disability income, critical illness, long term care and property-casualty coverages, to name just a few.

Placement of such coverages within an annuity structure (or vice versa) may offer significant sales, regulatory and tax benefits.

The recent run for annuities has been nothing short of remarkable, but designs must (and will) continually evolve. Its interesting to observe that such evolution sometimes involves returning to the past.

Timothy C. Pfeifer, FSA, MAAA, is a principal in the Chicago office of the Milliman USA actuarial consulting firm. His e-mail is tim.pfeifer@milliman.com.


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.