Variable annuities represent a major share of the retirement income market. But that position may be under threat by new, non-annuity retirement income products.
A majority of these companies believe the VA industry’s market share will decrease as these new products attract potential VA customers, according to a recent survey of 20 VA companies conducted by LIMRA International, Windsor, Conn. However, almost half expect that VA companies with guaranteed living benefits will retain their dominance in the retirement income marketplace.
With sales of VAs increasingly driven by the widespread availability of riders that guarantee income for life, the financial services industry has begun to expand structured retirement income solutions beyond deferred annuity products. Fidelity, Vanguard, and Charles Schwab are among firms that have introduced mutual funds designed to produce non-guaranteed regular income while still allowing access to any remaining account balance.
Other firms have tried other approaches using guarantees. Sometimes known as “synthetic annuities,” these products involve insurer-provided guarantees on non-insurance products or accounts:
o DWS Scudder, a Deutsche Bank company based in Kansas City, Mo., has designed its LifeCompass Income mutual funds to provide regular, fixed payouts over a 10-year period. A third-party financial warranty protects the distributions and at least a portion of principal.
o Allstate Financial, Northbrook, Ill., has rolled out 3 variable annuities that are intended to guarantee lifetime withdrawals from designated mutual funds, even if the account value drops to zero.
o Phoenix Life, Hartford, Conn. is offering Guaranteed Retirement Income Solutions, a product that “wraps” a lifetime income guarantee around an investor’s Lockwood Capital managed account assets. These assets must be invested in Lockwood’s specified asset allocation models.
o Genworth Financial, Richmond, Va., through its LifeHarbor group annuity, guarantees withdrawals from mutual funds or exchange-traded funds on AssetMark Investment Service’s managed account platform.
Even though many insurers remain committed to annuity product-based solutions to meet retirement income needs, these new income funds, accounts and products could cut into market share held by traditional VA products with guaranteed income or withdrawal benefits.
Some consumers who otherwise would have bought VAs could opt for fund-based solutions because of their flexibility and lower costs. And non-annuity products may end up appealing to individuals who would not have purchased VAs.
In terms of influence on the long-term VA industry outlook, a majority of the surveyed insurers believe the VA industry’s market share will decrease as the new products attract potential VA customers (see Figure 1). The remaining insurers tend to believe that, rather than cutting into VA market share, these new products will expand the retirement income market to include customers who wouldn’t otherwise buy VAs; this would present new sales opportunities for companies in this market and their distribution partners.
Despite expecting some loss of VA market share due to these new non-annuity income products, only a few of the responding companies predict that there will be a loss of dominance in the retirement income marketplace (see Figure 2). Of the 20 surveyed VA insurers, 9 said they expect VAs with guaranteed living benefits (such as guaranteed living withdrawal benefits or guaranteed minimum income benefits) will capture the largest market share within the next 5 years. Just over one-third believe it is still too early to determine which products will control the marketplace. Only 3 companies think mutual funds will dominate.
Many issues need to be addressed when evaluating prospects for offering non-annuity income products. The surveyed companies cite as examples the tax treatment of withdrawals and insurer capacity limitations for taking on additional risks. While most mutual fund or brokerage account distributions that result from capital gains are taxed at the appropriate capital gains tax rate, distributions from annuities are taxed at ordinary income rates, which can sometimes be substantially higher.
Several surveyed insurers believe the Internal Revenue Service’s capital gains tax treatment is not fully resolved and thus may be holding up development efforts.
Sales of VAs with lifetime income guarantees account for an increasingly large portion of deferred annuity sales. Currently, the guaranteed lifetime income risk assumed by VA insurers is managed through hedging programs and reinsurance agreements. If these insurers also underwrite lifetime income guarantees on non-annuity products, which could have much larger inflows than VAs themselves, then the industry may face volume limitations.
In addition, a company offering a guarantee on another company’s products will need to address issues such as how to link administrative systems and how to offer guarantees that are profitable.
Consumers will benefit as more retirement income options are made available to them. However, VA companies will need to manage this situation carefully as more companies offer non-annuity income products and compete for retirement income dollars.