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How The Life And Annuity Business Will Fare During The Crisis

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The year 2009 will probably go down as one of the most significant in the financial services industry.

The credit and liquidity crisis of 2008 has not fully played out so, as the new year unfolds, the crisis will continue to create havoc on company financials and market flexibility. In addition, the consumer pull-back on spending will continue to cramp the overall economy.

But what’s in store for the insurance industry in 2009? Here’s my take:

o Overall life sales will be down. However, life companies with financial flexibility and strength will enjoy sales increases. In general, the winners among the life companies will be those that can maintain strong financial strength while still delivering competitive product.

This means that companies that can continue to securitize reserves, obtain favorable letters of credit for reserves, have the ability to access the capital markets at reduced rates compared to the competition, and maintain their strong surplus position will become stronger than ever.

Producers and consumers will focus on company financial strength. The successful firms will be those that can differentiate themselves from the competition.

o Significant premium sales, such as hybrid premium financing, have all but dried up. Given the liquidity crisis, companies focused on these sales are seeing a tremendous drop in paid premium, and this will continue.

o Consumers are delaying or taking more time in the purchase process. But, on the plus side, it appears to be a given that after 2010, the estate tax will reveal its ugly head again, so consumers will again do some much needed planning. Gearing up for that will occur in 2009.

o Overall fixed annuity sales will increase. The spreads between FA rates and other fixed interest instruments such as bank certificates of deposit has finally widened to the point where customers are actively buying FAs having some sort of guarantee, be it guaranteed interest, accumulation, or payout rate.

Some FA companies may become even more competitive with annuity rates as they may decide that it’s less expensive to fund their cost of operations by buying annuity business rather than through normal credit financing.

o Overall fixed indexed annuity sales are a question mark. Two issues will really affect these sales: 1) possible oversight of FIA sales by the Financial Industry Regulatory Authority; and 2) pricing of options used to back FIA interest crediting.

Many FIAs today are sold by unregistered individuals who have refused to get, have given up, or failed to obtain FINRA licensing. These individuals have sold many FIAs, but if FINRA oversight is imposed and they remain unregistered, their FIA sales will evaporate. At one large FIA seller, less than 20% of producers currently have FINRA registration. Such firms would be severely impacted.

However, if FIAs are deemed securities, perhaps more broker-dealers would approve FIA sales. That would mean the product may be sold, but by perhaps a slightly different producer.

One worrisome aspect of FIAs in 2009 is the pricing of the options that generally back the upside potential.

Until 2008, volatility in the market was relatively calm. That allowed for higher caps and participation rates, given that volatility weighs heavily on options pricing, ultimately impacting FIA pricing, rates, caps, etc. Starting in late 2008, however, options became much more expensive for insurers to buy. Assuming this continues, it will depress caps and participation rates on new and in-force FIAs.

Will these lower caps be so low that traditional FAs become a better deal in the customer’s eyes? That is a question to explore as the year unfolds.

A compounding factor is the fact that the United States now has fewer investment banks that have the ability to sell these types of options. This shrunken market could increase the option price too.

o There will be a significant consolidation of insurance companies. Darwinian survival will sweep the industry.

Insurance companies that have the financial flexibility to ride out the economic downturn, whether by successfully issuing more stock or getting other financial assistance, will certainly be bruised, but they will emerge stronger than before.

In my opinion, 1,500+ insurance companies operating in the U.S. is just too many. True enough, many smaller insurers believe they can exist because they can satisfy certain niches and be more agile in delivering products. But in today’s economy, they are at a significant competitive disadvantage because they face higher cost of capital than do the larger companies and also lack comparable economies of scale.

Some insurers will find a merger partner. Others will lose enough from a ratings standpoint to curb their ability to garner new sales and thus go out of business. By year end, then, expect some well-known names to be all but gone.

o Guarantees will be strong sellers. Although universal life with no-lapse guarantees will continue to dominate life sales, companies that sell any contract with strong cash value guarantees will be able to grab sales as customers see the benefit of strong cash accumulation.

o Unfortunately, all the losses experienced in 401(k)s will continue to hamper variable sales–the spillover effect. However, sometime in 2009, one could argue that the perfect time will have arrived for consumers to reenter the market.

Overall, the insurance companies and producers that know how to satisfy a customer’s need–whether on the life or annuity side–will find that insurance remains a tremendous business to be in.

Michael S. Pinkans, CFA, CFP, CLU, ChFC, is the products and markets director for Brokerage Resources of America, in the Barre, Vt. office, and a registered representative and investment adviser representative for ING Financial Partners, Inc. His e-mail address is: [email protected]