Today’s economic needs and conditions are pushing for a more dynamic immediate annuity product.
A growing percentage of the population is already shifting from the accumulation to decumulation stages of life and considering multiple retirement product options. This is increasing demand for more consumer-friendly product solutions–ones that will transform the annuity market.
The life insurance industry is potentially the only source that can insure retirees against the risk of outliving assets. As such, it must either develop products that optimize appeal to retirees or remain stagnant. To do this, the immediate annuity products need to undergo a revolution.
What kind of immediate annuity would fit the bill? It must provide disclosure and flexibility.
Disclosure. Disclosure of product features is a key part of a possible product revolution. (See chart.) The key benefits of disclosure would be:
o Simple development of account value.
o Easy to produce and understand statements.
o Comparability of performance between the immediate annuity and other financial options.
Why are these disclosure elements so important? Conventional wisdom says consumers only seek products that maximize guaranteed payout from day one, and all else is irrelevant. But it’s unlikely that consumer research has ever been conducted that measures the value of full disclosure and flexibility.
Providing a fund value would give the customer a basis to measure the annuity’s returns, including interest and survivorship. If the customer needs to acquire additional guaranteed income, he or she could make an informed choice about the value of the contract versus alternate products. In some cases, other options within the contract may provide liquidity, so the disclosure could include that information as well.
A perceived disadvantage of the life annuity is the loss of the investment upon early death. Disclosing the credit–sometimes called a survivorship or mortality credit–that other survivors in the insurance pool receive would help enforce the financial advantage of using survivor financial assets to purchase the life annuity.
Consider the analogy of investing in common stock. When purchasing stock, investors expect to have an opportunity for greater return–with the risk of loss–than they would have if purchasing less risky investments. Similarly with the life annuity, annuitants would expect to realize additional guaranteed income as a result of the survival credit, with the potential for loss upon premature death.
Such disclosure would highlight how annuitants can optimize guaranteed income under a life annuity and would show the additional return attributable to the survival credit. While the life annuity is not an investment, the analogy explains the risk-reward relationship of the product.
Flexibility. The retiree population represents a wide range of markets with different financial requirements and risk tolerance, so flexibility is important. Let’s consider just some of the flexibility options:
o Interest options: Normally, one would expect retirees to want to lock in the highest guaranteed interest rate to maximize current guaranteed income. However, when interest rates are low, they may prefer to lock in a lower guaranteed rate–with the possibility of current interest, which may increase over time. Here, the option of guaranteed and current interest credits would have appeal.
o Survivor credits: The life insurance industry is very concerned, and rightly so, with mortality improvement creating huge losses under a life annuity. The availability of a product with current and guaranteed survivor credits would provide the industry with the flexibility to assume best-estimate survival rates and provide higher guaranteed rates. The difference between current and guaranteed survivor credits and interest rates may be used to provide additional income or liquidity funds to enhance future flexibility.
o Combinations: A new immediate annuity could be used in combination with period-certain and life annuities, deferred life annuities and other options. This would expand flexibility for retirees.
The range of flexibility is limited only by imagination and market needs.
Flexibility is important for 2 reasons. First, since the retiree market is not monolithic, a segment of the market will want flexibility that can be found in an unbundled product. (Incidentally, it’s hard to argue that unbundled annuity products will be too complicated; current retiree financial plans already use stochastic analysis to predict future returns).
Secondly, the market’s diversity would create opportunities for insurers to tailor the flexibility to customers’ market sophistication and access to advice.
To address concern that retirees will determine annuity income based on non-guaranteed rates, insurers can respond by only permitting income based on guarantees.
Distribution is key. So is educating distributors about retiree market needs, which can be expanded to encompass product education too. While some critics believe current products do not appropriately compensate distributors for ongoing services to retirees, introducing a fund value could facilitate asset-based compensation. Figure 2 identifies the range of services required in income planning. Redeploying excess interest or survivor credits to provide income would open up an opportunity for creative approaches to distribution compensation.
In sum, innovation in this market is not about making immediate annuities the vehicle for all accumulated assets of retirees. Rather, product revolution would help ensure that life insurers are the providers of choice when the retirees seek a financial product they cannot outlive.
The industry has been developing many products intended to provide this guarantee, including lifetime guaranteed withdrawal benefits, deferred life annuities and period-certain annuities with flexible withdrawal options. Such products can address specific retiree needs. However, a more revolutionary product could encompass these options within a framework and thus address a range of needs.
Most market players already know the elements of an immediate annuity. Creating a more dynamic annuity would not require a leap of faith, particularly given the market prospects. The payoff could be substantial.
Jesse M. Schwartz, FSA, MAAA, is a consulting actuary in the insurance and financial services practice of Watson Wyatt Worldwide, New York, NY. His e-mail address is: