Today’s variable annuity world is more complex than ever, and the old rules no longer apply. So forecasting for 2009 is challenging.
The year 2008 has much to do with this. It saw seismic equity market declines in the United States and abroad and a steepening yield curve that resulted in short-term Treasuries yielding just a few basis points and credit spreads reaching historic levels.
Fixed annuity sales expectedly spiked. VA sales softened but their decline was relatively controlled–due largely to the proliferation of guaranteed living benefits, the sweetening of their provisions, and their embrace by clients and distributors.
Insurers responded to the demand by accelerating new GLBs, strengthening hedging programs and seeking capital relief through cooperation with regulators. These steps were helpful but market declines ultimately exerted negative cost pressures. So, as 2008 wore on, insurers increasingly raised GLB charges, diminished guarantees, and eliminated certain GLBs completely.
What, then, to expect for 2009? With no benefit of clairvoyance, let’s start with a reasonable assumption–namely, that volatility in the broad equity markets will continue for the first two-thirds of 2009 with broad indices operating in a plus or minus range of 10%-12% from year-end 2008 levels. In the last third of 2009, assume sustained broad market growth of 12% or more. Such an environment may lead to the following developments:
GLBs: These features will not go away. They are too popular, and threats from emerging mutual fund/managed account guarantees, withdrawal guarantees on other annuity types and totally new guaranteed income structures are too real. Further, some well-capitalized insurers who have stayed away from GLBs will join the party, in anticipation of a bottom to the equity markets. Insurers will raise GLB prices by as much as 30%-50% and pare back benefits by lowering roll-up percentages, slowing ratcheting, increasing waiting periods, and further tightening asset allocation requirements.
On the other hand, some stronger GLWBs will appear, such as inflation-adjusted withdrawal amount guarantees. Reinsurance will be very difficult to obtain at attractive prices until late in the year, but insurers will continue to work with regulators to establish more permanent solutions to VA capital requirements in bear markets. Insurers may also seek ways to address market risk, by selectively adding modest out-of-the-money GLBs to older in-force VAs, and by hedging lost mortality and expense risk charges and other fees more directly.
Incentives for new buyers: Even as the focus on retirement income continues, VA sales will need a boost in 2009. A possible approach may be to ease hesitant investors back into VAs by offering attractive rates on fixed subaccounts for moderate periods and revisiting enhanced dollar cost averaging approaches for longer periods. Bonus VAs will gain more market share.
Subaccounts: Activity in 2009 will continue to be in asset allocation mixes of funds, and the average number of funds offered in a typical VA will continue its steady decline. The importance of GLBs in VA sales will drive this movement toward fewer, more “packaged” investment choices. Insurers will continue to prefer sub-advised asset management structures.
Charge levels: Overall VA charge levels will rise modestly, due mainly to increases in GLB charges, which will offset small overall reductions in average base contract charges.
Other possible developments in 2009:
o Fewer new product launches, as insurers work to refine existing products and manage in-force VAs.
o Continued growth in the market share of qualified VA sales versus non-qualified sales, as GLBs strengthen the case for VAs in qualified plans.
o Revisiting of the merits of A-share VAs, which reduce the reliance on uncertain future M&E and other asset-based charges.
o Limited new activity in guaranteed minimum death benefits and traditional variable immediate annuities.
o Increased discussion of lowering upfront sales compensation, particularly in banks, in favor of shifts to more trail compensation which lowers persistency and market risks to insurers
External factors like regulatory and tax law changes will inevitably influence VA direction, especially with a new administration taking office in 2009. Past sales practices will be scrutinized in hindsight if the market does not rebound.
Amid all this bleakness, one thing is certain. VAs will continue to play a vital role in securing retirement income solutions for the population. The question is, when can industry players come out of their foxholes?
Timothy Pfeifer, FSA, MA, is president of Pfeiffer Advisory, LLC, Libertyville, Ill. His email address is [email protected]