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.”
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.
Just ask those who have seen their 401(k) balances drop by 60%. Ask those who now feel that they must work another 10 years to afford retirement. Or ask those families where both spouses must stay in the workforce. Ask them all whether a 100 basis point haircut every year would have been onerous, versus the real punishment they have actually endured.
Recent market events have brought home to them the very real risks of being “uninsured” in the area of equity exposure.
Here, then, is the challenge: Insurers should not be expected to offer guarantees at prices that are unprofitable and which consume huge amounts of capital. On the other hand, charging an appropriate price for today’s designs often results in prohibitive fees which drag down the entire value proposition of the retirement product.
What can be done? This gets dicey for several reasons. First, guaranteed benefits are a critical engine driving retirement sales for many insurance companies and asset managers. Next, today’s hazardous hedging environment will eventually fade, and current designs will then be economic to sell again. But manufacturers who have departed the market will face challenges in restoring their future market position.
Why not consider a manufacturing strategy that focuses on preserving a 100 basis point guaranteed benefit price and alters other benefit/economics components to accommodate that? (See chart.)
Because these benefits have significant value in the eyes of sales reps and customers, all options to keep them feasible and appealing should be considered–including lower sales compensation. A 100 basis point target charge level can keep the benefit meaningful, without depleting base investment returns severely.
The insurance industry has a unique opportunity to help grow and maintain investors’ retirement plans. The guarantee of longevity protection is one component. The guarantee that, for a modest annual cost, an investor’s nest egg will be protected, is a critical component as well.
A 100 basis points charge is worth much more than that for the peace of mind it brings. Industry professionals must work together to convey that message to clients.
Timothy Pfeifer, FSA, MAAA, is president of Pfeiffer Advisory, LLC, Libertyville, Ill. His email address is email@example.com