Insurers and asset managers need to find ways to stay in the business of providing guaranteed living benefits to investors. There is a way to do this safely.
First, let’s see why this is critical. It has to do with how customers react to loss.
Investor surveys consistently show that, for a significant portion of the population (maybe even a majority), the pain resulting from losing X% on an investment is greater than the satisfaction enjoyed in earning the same X% as a positive gain.
Some of this can be explained by the principle of inertia. This psychological theory holds that, upon reaching a certain level of assets or account value, investors and policyholders consider the new level to be their new permanent “steady state,” a level of wealth they have earned and which they “deserve.”
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But declining markets, such as today’s, can erode this steady-state entitlement, bruise egos and cause much distress. This raises a legitimate question of how much customers are willing to pay to avoid such a battering.
The need does exist. After all, if an investor wants to participate in the market for accumulation and retirement income purposes, and not hide completely under a short-term fixed yield rock, the customer will need a blanket of protection on those assets. The guaranteed return features on variable life, variable annuities, mutual funds, and indexed products do provide such protection. But the cost of that protection is becoming problematic.
Until about 6 months ago, insurers typically charged 50 to 100 basis points per year for their guaranteed minimum benefit features on life insurance and annuities. They also set some limits on investment exposure.
Today, however, insurers and asset managers have realized they have not been charging enough for this insurance. Low interest rates (the main culprit) and high implied volatility have necessitated re-pricing, with some carriers reluctantly raising the cost above 100 basis points, to 125, 150, or even 175 basis points annually. Other insurers have reacted by pulling certain products and even exiting living benefit guarantees completely.
But completely avoiding these guarantees is not necessary. Even with higher prices, the benefits meet the definition of prudent insurance for today’s investors. In fact, aside from the technical justification for current charges of 100 basis points or more (i.e., swap rates, implied volatility, etc.), a serious equity investor/policyholder should have no difficulty paying 100 basis points annually today to protect his wealth.