Variable Annuity Sales Hit Record $128.4 Billion In 2004

Unlike standard GMWB features that are priced in the 20-50 basis point range, (depending upon the clients choice of a 5% or 7% rate), the GMWBs-for-life are priced higher, ranging from 60-90 basis points on average. The issue age will determine the actual percentage load with some products, and the withdrawal amounts seen to date have averaged 5%. Inasmuch as 2004 saw the expansive growth of standard GMWBs, in 2005 we should expect to see a widespread addition of GMWB-for-life features to the many VAs despite their higher cost.

The majority of advisors today see the GMWB-for-life as a viable alternative to recommending true annuitization of deferred contracts or the purchase of immediate annuities to solve for income distribution management and corresponding longevity risk. For the majority of advisors, not only are the perceived loss of control issues avoided but so are the explanations of the mechanics of variable annuitization. Not having to explain an AIR and the annuitants payout options avoids what many see as a painful exercise.

Additionally, deferred contracts paying 5-7% commissions are more attractive to commission-based advisors than contracts that, for the most part, provide little or no compensation upon annuitization. As long as there continues to be such a wide disparity in commission structures, we can expect the use of lifetime contract annuitization to remain relatively unattractive to advisors. Some distributors with whom we have spoken have been vocal about the need for commissions in deferred VA contracts (especially the B-share) to drop. Additionally, some distributors feel a reduction in the 6-7% VA gross commission rate could result in a corresponding reduction in the overall number of compliance and suitability complaints due to compensation conflicts of interest.

The advent of the GMWB-for-life has begun to spark dialogue on the long-term implications of these features. Some argue that the GMWB feature is a bridge to a greater understanding and use of lifetime payouts and that it will ease the way to greater use of immediate VAs and true annuitization of existing deferred contracts. Yet there is concern that the ultimate cost to issuers in reserving for this non-diversifiable feature could be significant enough to jeopardize the financial stability of the industry, should many millions of Americans choose to utilize the GMWB-for-life benefit in lieu of IVA purchases or true contract annuitization. We suspect this dialogue between the diversifiable risk of true annuitization vs. the non-diversifiable risk of GMWBs for life will continue.

Another trend for 2005 will be the continued focus on VA sales targeted at the qualified marketplace. The $13 trillion in combined IRA/401(k) statistics represents an enormous market opportunity. Many advisors who recently participated in our in-depth surveys noted that they were educating themselves to become retirement rollover experts, and some had shifted their practices to focus exclusively on the qualified plan market and early retirement clients. For example, advisors living in areas where industrial plants are located had begun to conduct tax and estate planning seminars (in some cases in conjunction with employers) to assist pre-retirees with retirement cash flow planning in anticipation of their 401(k) rollovers. Advisors noted that the average 401(k) rollover for blue-collar workers leaving many of these plants after a lifetime of service ranged from $800,000 to $1.5 million.

An analysis of the VARDS numbers bears this out. In 2001 qualified VA sales (excluding group VAs) totaled $43.3 billion. At the end of 2004 that figure had increased by 35% to $58.5 billion. In contrast, nonqualified sales for the same period remained static at $49.1 billion in 2001 vs. $50.1 billion at the end of last year. Additionally, qualified VA sales were 68% of 2003-2004s non-group sales growth. Factors contributing to the growth of qualified sales include the decline in tax benefits for nonqualified investments and the growth of living benefits, particularly the GMWBs.

Some distributors also note that their NQ sales volume was down in 2004 due to a growing number of advisors shying away from VAs as a result of growing suitability and compliance concerns in a highly focused regulatory environment. It is important to note that these statements may not be representative (and thus may not be predictive) of the industry as a whole and may only be unique to the few distribution organizations with whom we spoke. Nevertheless, these statements are significant.

In the category of sales by distribution channel, there were no dynamic changes, as was the case in 2003 when the bank channel grew by 40% to a market share of 14%. Driven by a very low interest rate environment in 2003, coupled with an explosive stock market in the wake of the extended bear market which favored VAs over fixed annuities, the channel remained unchanged, ending the year with the same market share as it began. Direct response and the captive agency channels also remained unchanged in 2004. The independent NASD firm channel gained market share, ending the year at 31%, up from 26% the previous year. Both New York wirehouses and regional investment firms lost market share by 2% and 3%, respectively. Similarly, there were no significant changes in the category of VA assets by investment objective. Overall allocations to all equity funds continued in 2004, albeit a slower pace, closing 2004 at a share of 55.9% vs. 54.1% in 2003.

In our last installment we provided a complete review of additional product developments that would have an impact in 2005. These included longevity insurance, use of Exchange Traded Funds and new fund investment ideas, persistency and annuitization bonuses, dynamic asset allocation tools, and continuing efforts to improve the overall costs basis of VA contracts by charging M&E fees on premiums vs. account value. The industry will continue to bring to the market an ever-widening range of features and options in 2005. The challenge (also noted in our last commentary) is to do so in an environment of overall product simplification and disclosure while lowering costs to the consumer. To this end we look forward to its progress.

Rick Carey is managing director-research, of VARDS, a unit of Morningstar, Inc.

Reproduced from National Underwriter Edition, March 4, 2005. Copyright 2005 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.