By Rick Carey
Driven by the insurance features of living benefits and the best-sustained equity market returns of the past 4 years, variable annuity new sales posted an 11% increase in 2003. New sales of $124.6 billion came close to the all-time previous new sales record of $128 billion set in 2000.
Year-end 2003 total industry assets of $985.4 billion are near the all-time high of $1 trillion reached in June 2000. The 2003 VA industry asset growth rate of 23.7% was impressive, considering those assets had declined every year during the 2000-2002 period.
In 2003, living benefits were to VAs what technology stocks were to the NASDAQ. The growth of living benefits during the bear market years defined their success. The big 3 are guaranteed minimum income benefits (GMIBs), guaranteed minimum withdrawal benefits (GMWBs) and guaranteed minimum accumulation benefits (GMABs). Excluding closed and group VA contracts, 75% of last years new sales were in contracts with one or more of these living benefits.
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GMWBs, the newest of the trio, were the benefit of choice in 2003. First introduced in mid-2002 by Hartford as the Principal First benefit, 40% of last years new sales were in products that had a GMWB. We can contrast their growth with that of the GMIB, where 52% of new sales were from products with an income benefit.
Why have the withdrawal benefits grown in popularity in 2003 at the expense of the income benefits? The explanation is as much a story of actuarial risk to the insurer as it is ease of understanding for the customer and sales agent. The recent bear market dramatically heightened interest in protection from downside risk and preservation of principal.
GMIBs were designed to provide clients the protection and income insurance they were seeking for annuitized income. The bear market, coupled with the GMIB design, however, raised numerous red flags by rating agencies that deemed the benefits inherently risky. In particular, they noted the difficulty in both hedging the risk and the obligation to cover the guarantee without solid data to predict future annuitization rates. Additionally, suitability and compliance concerns have increased, centered on customer and sales agents potential misunderstanding of the benefit structure.
Current producer research performed by the VARDS Greenwald Strategy Service found most sellers lack knowledge of the GMIB structure. It is possible buyers may not fully understand the difference between the benefit annuitization interest rate (generally 2.5% and age set-backs) vs. the promoted 3% to 6% annual return on premium.
Enter the guaranteed minimum withdrawal benefit. The feature has grown in popularity during its short existence due to the sales success Hartford has generated with the benefit. Investors see the benefit to recovery of principal regardless of market performance. Another benefit seen by some sellers is consumers do not have to annuitize their contract to receive the benefit. The sales success of GMWBs will continue to attract more buyers in 2004. The percentage of new sales from contracts offering a GMWB also is likely to surpass those of the GMIB this year.
Some 80% of the Top 25 nongroup contracts offer one or more living benefits. The nongroup Top 25 excludes VALICs Portfolio Director Plus, the TIAA-CREF annuity and INGs Account C. The replacement contracts include Nationwides The Best of America-Americas Future Annuity, Prudential/American Skandias Strategic Partners and Pacific Lifes Pacific Portfolios. In this group, 14 have a GMIB, 12 have a GMWB and 5 have a GMAB. In this group, 6 contracts added a GMWB feature in the second half of 2003, confirming the momentum of this features growth. Additionally, 12 of these contracts made changes to their death benefit charges and/or structures in the past year.
In 2003, 84% of the Top 25 issuers posted positive sales growth over the previous year. Five firms grew their sales by a margin of 50% or more. They include Hartford Life (51.44%), Equitable Life (61.2%), MetLife/NEF/Gen Am/MLI (54.2%), Jackson National Life (51.5%) and Guardian Insurance & Annuity Company (144.3%). Out of last years Top 25, 13 issuers (52%) moved up in rank from the previous year. Seven firms (28%) kept the same rank and 5 firms (20%) dropped in rank. New to this years Top 25 are Security Benefit Life, Ohio National Life and Guardian Insurance & Annuity. The issuers who left the Top 25 since 2002 include Phoenix Life, Kemper Investors Life and Allmerica.
The trend toward VA industry consolidation and increasing concentration of sales continues to pick up momentum. The market share of new sales for the Top 25 VA issuers at the end of 2003 was 94%. At the end of 2002, it was 89.1%.
More telling evidence can be found in the market share consolidation of the Top 100 VA contracts. This group of contracts share of new sales grew by 17.2% in 2003. At the end of 2002 the Top 100 contracts share of new sales was 70.52%; by the end of last year it had increased to 82.7%. The success of multiple product lines and the growing demand for proprietary VA contracts continues to grow assets for a number of issuers. The following firms/enterprises each marketed 6 or more contracts in the Top 100: Hartford Life (10), ING (8), Nationwide (6), MetLife/NEF/Gen Am/MLI (6), Lincoln National (6), Prudential/American Skandia (6) and AIG/SunAmerica/VALIC (6).
With 12 out of 55 VA issuers with total VA assets under management below $1 billion (as tracked by VARDS), further industry consolidation appears likely. The financial strain of the bear market on VA issuer fee-based revenues coupled with forthcoming increases in risk-based capital requirements will hasten overall industry consolidation in the coming years. The critical asset mass necessary to maintain profitability on the overall book of VA business has increased dramatically over the past decade. In 1990 issuers with $500 million to $1 billion in annual VA sales were considered to be among the VA leaders. Today, a Top 10 VA issuer (excluding TIAA-CREF) has an average new sales volume of $7.4 billion and $44.8 billion in VA assets under management. Scalability in the VA industry has undergone tremendous growth. During the period 2005 through 2007, we estimate a 10% consolidation in the ranks of VA issuers.
What does increasing consolidation mean to the marketplace? Less competition will ultimately mean that brokers and consumers will have fewer product choices. Above all, insurance marketing executives are interested in what sells best. History confirms the VA marketplace is quick to replicate the hottest selling feature. The success of the GMWB is the most current example. The run to duplicate may force many potentially valuable product ideas to remain on the cutting room floor. With product profitability based on larger sales models, many niche products may never reach the market.
Two other widely followed benchmark improvements witnessed in 2003 were most notably the percentage of 1035 Exchanges and industry net flows. VARDS estimates last years 1035 exchange rate dropped to 48% (expressed as a percent of total industry sales). That figure is a 7.7% improvement over 2002s 1035 estimate of 52%. Estimates for the years 2000 and 2001 were 46% and 50%, respectively. VARDS arrived at these estimates by comparing reported net cash flow to total reported sales, less approximations for surrenders (including full and partial withdrawals and cash value released upon payment of death benefits and annuitizations). Surrenders were estimated at 3% of the average of quarter-end assets under management.
While 2003 new sales were up 11% and total net assets grew by 23.7%, net flows grew by 49.8%! The importance of this benchmark cannot be overstated, as it is a barometer of VA marketing success for the industry as well as for individual issuers. Last years net flows of $46 billion were 36.9% of new sales. By comparison, in 1994 net flows were 91.6% of new sales. The percentage has been falling every year since then until 2003.
This change in the long-term decline of the percentage is significant. For the industry it means an inflow of new capital. For too many years the industry has been acutely aware that first-time buyers of VA contracts have been declining. Issuers have relied upon intercompany VA contract exchanges to grow business as products matured past their contingent sales charge periods.