It has been said that immediate annuities are number 4 on every life insurer’s annual “to-do” list, but that most companies only have time for the top 3.
A few insurers seem to have decided to move immediate annuities up a notch, but more should join in.
Consider the landscape: Fixed immediate annuity sales in 2006 were $5.9 billion, according to LIMRA International. In the first quarter of 2007, fixed immediate annuity sales totaled $1.5 billion, a 7% increase over the first quarter 2006. Although those first quarter sales represented only 2.6% of the total individual annuity market, the coming waves of baby boomer retirements suggest this will likely be a growing segment in the years ahead. For that reason, establishing market share in this market, now, could create significant sales down the road.
Innovations are slowly surfacing, as can be seen from a recent Milliman, Inc. survey of 25 carriers (see chart).
For the industry to embrace this product and give it the attention it deserves, a number of challenges must be overcome. Examples are highlighted below:
Mortality data and longevity risk management: The life insurance industry is flush with mortality data and the reinsurance marketplace is well established and readily available to help manage the risk of insureds dying too soon. Longevity data is a different story. There is a considerable amount of Social Security Administration and other population-type data, but these do not include the self-selection aspects of purchasing an immediate annuity.
The thought is that the typical purchasers of immediate annuities will be fairly confident about their health and will likely expect a longer life expectancy than the general population. Major reinsurers are talking about providing longevity coverage and the capital markets have suggested a few instruments, but the market is far from well established.
The Milliman survey found no clear consensus on mortality assumptions used to price immediate annuities. The industry uses nearly every combination of annuity mortality rates and mortality improvement rates to price these products.
Investment returns: Investment return expectations are a critical component in pricing immediate annuities. The historically low 10 and 20-year Treasury rates and the compression of corporate spreads have put pressure on the investment return expectations that insurers use to price immediate annuities. Increased rates at the long end of the curve have begun to relieve some of this pressure, however.
A potentially larger challenge is the relatively low priority that insurers place on immediate annuity investment strategies. Immediate annuities have unique investment challenges. Particularly, life contingent annuities and the increasing prevalence of liquidity and optionality will only make investing more challenging.
The relatively low historic sales volume has made creating a dedicated portfolio or investment strategies inefficient.
However, as more companies look at outsourcing the management of specific asset classes, there may be an opportunity for companies to outsource the investment management for this relatively minor product, at least until scale is reached.
Product development tools: The types of liquidity features and elective options that characterize today’s immediate annuity marketplace are certainly not prevalent in many tools used in pricing these products.
These features can be complicated and can have significant implications regarding anti-selection and other risks. It has been a challenge for insurance companies to dedicate significant internal resources to a product that has historically produced relatively modest sales.
Sales and product presentation: One of the largest challenges the industry faces is simply getting the immediate annuity “story” out to the public.
It is often difficult for the average person to appreciate the value of a stream of income that cannot be outlived, and the insurance industry has not yet found the best way to communicate this benefit. In this era of disappearing defined benefit plans, it will be common for a person to retire with a 401(k) balance of less than $500,000, a bit of money in the bank, and Social Security. Therefore, it will be critical to assist such individuals in seeing the value of converting at least a portion of the $500,000 into a reliable “paycheck.”
In sum, to stay ahead of the competition, more insurers need to move immediate annuities up on their to-do lists. Developing solutions to the challenges above will enable them capture a share of the lifetime income opportunities that are on the way.
Timothy E. Hill, FSA, MAAA, and Susan Sell, FSA, MAAA, are consulting actuaries with Milliman Inc. in the Chicago office. Their respective e-mail addresses are firstname.lastname@example.org and email@example.com.