After record-breaking first quarter new sales of $34.4 billion, variable annuity second quarter new sales fell 4% to $33 billion.
Year-to-date new sales of $67.4 billion are 54.7% of last year?s new sales of $124.8 billion and represent an 8.7% increase over year-to-date new sales for the same period a year ago. Year-to-date total net industry assets closed at $1.05 trillion, up 1.75% over first quarter assets of $1.03 trillion.
The recovery of the equities markets in 2003 faltered in early March as concerns over rising interest rates, oil prices and the war on terrorism brought single-digit declines in the major market equity indexes as the quarter came to a close. Concerns over first quarter corporate earnings sent the major market indexes into negative territory again in April. They recovered in June, enabling the S&P 500 and the NASDAQ Composite to post mildly positive year-to-date returns of 2.6% and 2.2%, respectively. The Dow Jones Industrial Average lost .18%.
As we began the third quarter, lower than expected corporate earnings for the technology sector continued to drive the equity markets lower in July, with the NASDAQ posting the most significant losses. As of early August, the year-to-date returns for the NASDAQ Composite, the S&P 500 and the DJIA are -11%, -3.2% and -4.9%, respectively.
This year?s equity market performance is in marked contrast to last year?s stellar double-digit positive performance. Profit warnings, terrorist concerns, Iraq, rising interest rates and commodity prices all continue to dominate investor psychology. Concerns with the performance of the equities markets, as well as the costs in time and public perception to address the heightened regulatory focus on suitability and compliance, have prompted some VA issuers to forecast lower than expected sales for 2004.
Inasmuch as equity market performance is the final arbiter of sales success or failure in the VA marketplace, net flow is the barometer of the underlying health of the industry. For the industry, it is the gauge of new money coming into the industry, as opposed to money already inside the industry flowing between companies in the form of 1035 exchanges or heightened surrender activity.
In 2003 the industry witnessed the most significant annual growth of net flow (by percentage) since 1994, up 49.8% over 2002. While first quarter 2004 net flow of $9.7 billion was down 26% over the same quarter in 2003, second quarter?s net flow of $12.5 billion was down only 4.6% over the same quarter in 2003. Year-to-date 2004 total net flow of $22.2 billion is 48.3% of last year?s level of $46 billion. Considering the state of the equities markets and the extensive press coverage given to the industry?s late trading and compliance and suitability issues, VA industry net flow remains on a positive footing.
The VA industry issuer landscape continues to consolidate. With MONY announcing the completion of its merger with AXA Financial in July and the April completion of the Manulife acquisition and integration of John Hancock Financial Services, the industry has 2 fewer VA issuers. Lower profit margins from asset accumulation products demand maximization of economies of scale, which will continue to foster even more industry consolidation. Rising costs to meet increasing suitability and compliance requirements, coupled with pending implementation of new risk-based capital requirements, add additional pressure for smaller VA market share issuers to maximize profit margins and shareholder valuations.
Sixteen of the current 53 VA issuers (30%) hold less than $2 billion in individual total VA net assets, and the Top 25 VA issuers? market share of total new sales continues to rise?it is now at 95%. Excluding the assets of TIAA-CREF, average VA assets for a Top 25 VA issuer are $27 billion, and for a Top 10 VA Issuer, $49 billion. Unless the anticipated VA life annuity retirement income market boom materializes sooner than later, 28 issuers sharing the remaining 5% in sales market share seems questionable over the long term.
For customers, the benefits of consolidation should come in more favorably priced products. For the industry, product consolidation, while potentially cutting the choices available, could lead to increased sales compensation from efficiencies in economies of scale. Enhanced compensation packages are especially important for the success of life annuity sales.
For VA issuers, one measure of sales success is the quarterly sales ratio. As of mid-year 2004, 17 of the Top 25 VA issuers (68%) had sales ratios of 50% or higher. Seven firms had sales ratios of 60% or higher. Of this group, Lincoln National?s 80.6% sales ratio was the highest, followed by Allianz at 80%. These 2 companies also have the 2 highest percentage changes in sales for the annual year-to-date period ending 6/30/04 at 93.8% and 76.2%, respectively.
Other VA issuers in this group of 60% plus year-to-date sales ratios (listed by %) include Manulife/John Hancock (67.3%), Travelers Life and Annuity (65.6%), ING (63%), Prudential/American Skandia (61%), and Northwestern Mutual (61%).
Over the past year ending 6/30/04, 17 of the Top 25 VA issuers had increases in sales ranging from 93.8% to 1.1%. The remaining 8 issuers had decreases in sales ranging from -1.2% to as much as -57.7%. Explanations for a loss in sales over the period range from dropping or decreasing product benefits (especially living or death benefits), realignment of product distribution, closing of products and increased surrenders (especially from C-shares), and loss of investor confidence and distributor loyalty due to heightened exposure from market-timing and sales practice issues.
While the investment performance of an issuer?s money managers has not been the driving force for VA sales during the bear market (replaced by investor focus on features and benefits), the reemergence of investment manager performance as the primary driver of VA investing seems likely to gain momentum as investors and brokers focus on portfolio management. A recent Lehman Brothers report on insurers with top-rated funds in their products as an investment component of stock valuation may be a precursor of this trend.
The VARDS database currently ranks the following firms in the category of Top 10 Investment Management Complexes, in order of assets under management for all contracts in the VARDS database. (The percentage change in assets from 12/31/03 is also provided in parentheses.) The firms are TIAA-CREF Trust Company at $159.2 billion (4.1%); Capital Group of Companies, $48.9 billion (15%); Wellington Management Co., LLP, $48.1 billion (4%); Fidelity Investments, $44.6 billion (2.3%); Alliance Capital, $30.3 billion (3.5%); Sun Life Financial, $27.4 billion (4.8%); Putnam Investment Management, LLC, $23.6 billion (-4.7%); Pacific Life, $19.9 billion (8.7%); Franklin Templeton Group, $16.6 billion (16.7%); and Morgan Stanley, $16.6 billion (7.1%).
In the year-to-date period ending 6/30/04, Franklin Templeton held the largest percentage change in assets at 16.7% and moved in rank from 14th at the end of 2003 to 9th place. Analysis of VARDS data reveals that approximately 80% of Franklin Templeton?s fund growth is coming from VA contracts issued by Hartford. The largest asset growth, $1.3 billion, came from contracts in the Hartford Leaders series. Of this total, $893 million reside in the Hartford Leaders Outlook and Hartford Leaders contracts. Of Franklin Templeton?s funds, their Mutual Shares Securities Class 2 and Strategic Income Securities Class 1 hold the largest share in growth of assets for the mid-year period.
A significant trend developing this year is growing distributor interest in the use of A-share contracts. The enforcement actions involving Morgan Stanley and MFS have prompted a growing number of brokerage firms to evaluate carefully all areas of potential suitability and compliance exposure. Some broker dealers feel that by reducing or eliminating the opportunities for conflicts present within the various share class products? commission structures, the exposure for abuse will be substantially reduced. Additionally, a growing number of industry veterans feel that the VA industry is embarking on a new era in the aftermath of last September?s late trading investigations. On the regulatory front, the confirmation and transaction rules promulgated in proposed SEC Rule 33-8358 represent the most significant proposals likely to impact VA product development of the last 20 years.
Commenting on these regulatory developments, industry veterans Norse Blazzard and Judith Hasenauer noted last spring in a National Underwriter article: “It is too early to predict specific results, but it is possible to predict certain likely developments almost sure to take place which will have significant impact on VA and VL policies. It is likely that the current way products are priced will change.”
Requests by a number of VA distributors over the past few months for issuers to provide front-end load A-share versions of their contracts would seem to confirm the anticipated impact these proposals could have, should they become law.
Presently only one national wirehouse has the majority of its VA sales coming from an A-share product, and VARDS mid-year sales statistics reveal only 2.5% of VA new sales reside in A-share products. But that could change sooner than later. According to Hasenauer, “While I do not believe A-share VA products will become the dominate element of the distribution choices, I do think it will become a significant part of it. Significant could be described as 30% or 40% of the total VA business.” At those percentages, the A-share could become the largest share class behind the B-share, which comprises 45% of all non-group contracts in the VARDS database. Since 2001, VARDS has added more B-share contracts to its database (110) than any other share class product type.
A-share contracts are used so infrequently today that out of 749 non-group contracts in the VARDS database, just 15 are A-shares. Only 2 new A-share contracts have been added to the VARDS database since the end of 2001. Issuers presently are working with distributors in new A-share product design and working through pricing issues as well as key structural issues such as rights of accumulation, etc. If Hasenauer is correct, we could expect a few hundred new A-share products from the Top 50 VA issuers to come to market over the next few years or perhaps sooner.
Other arguments for using A-shares range from lower internal insurance costs, which can provide for greater internal customer account values, to “stickier assets.” With so few A-share assets to evaluate industrywide, it is impossible to confirm that A-share assets would be any “stickier” than those of the B-share. Brokers might consider that the lower upfront client commission would warrant a shorter amortized holding period when compared to a B-share?s higher contingent deferred sales charge. Also, the upfront payment of the sales commission might actually benefit smaller VA issuers who would not have to reserve against large blocks of CDSC liabilities.
Another share class trend observed this year involves the C-share contract. Over the past 2 years, sales of C-share class contracts (as a percentage of non-group sales) have dropped off from an average of 18.2% in 2002 to 9.9% in 2003. This year sales have dropped by almost 1% to a mid-year average of 9.1%. More importantly, over the past 3 years, C-share class contracts have held the lowest cumulative percentage of net flow to new sales of all share class type contracts at 49.2%. Bonus contracts have the highest percentage at 88.2%, followed by A-shares at 87.7%. B-shares rank third at 81.8%, and L-shares rank fourth at 77%. These statistics seem quite incongruent considering the fact that the number of C-share contracts issued over the past 3 years has continued to rise from 94 at the end of 2001 to 165 as of mid-year 2004. With sales of C-share products declining, coupled with the lowest cumulative percentage of net flow to sales of any share class, the future of the C-share seems questionable.
In many ways, 2004 appears to be developing as a pivotal year for the VA industrya year of transition that could witness the most significant product development movement of the last 25 years, should the prognosis of many long-time industry observers prove correct. While the financial stability of the insurance sector has made significant improvement this year, as evidenced by the early July Moody?s upgrade from negative to stable, forthcoming 2005 risk-based capital requirements will place additional financial pressure on VA issuers. As Moody?s noted in its upgrade report, “Nevertheless, we believe the life industry?s risk profile continues to be pressured by recent setbacks and long-term cyclical changes affecting the industry.”
In today?s operating environment, VA profitability economies of scale favor the larger players. While bigger may not always be better, it may be safer. Further industry consolidation appears likely as the critical mass for VA assets under management continues to grow to historic levels. And last but not least, the performance of the equities markets will always be the final arbiter of success in the VA marketplace.
is managing director of research and the founder of The VARDS Report, a Roswell, Ga., publisher of annuity statistics. VARDS is a product of Finetre Corporation. He can be reached via e-mail at firstname.lastname@example.org.
Reproduced from National Underwriter Life & Health/Financial Services Edition, September 3, 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.