Swapping old annuities for new–also known as 1035 Exchanges–accounts for half of all indexed annuity sales (see NU 6/23/09) and over 80% of variable annuity sales (see NU 11/3/08).
However, three main elements will cause annuity exchanges to drop sharply in coming years.
Increased focus on suitability in annuity exchanges. The 2003 version of National Association of Insurance Commissioners’ Model Regulation 275 required producers to make suitable recommendations for annuity buyers over age 65 (later expanded to include all annuity buyers). It also required carriers to develop procedures and reviews to detect violations. It made violations of these rules subject to “appropriate corrective action” by the state insurance commissioner.
Now comes the May 2009 revised draft of Model 275. This draft specifically says that the insurer may not issue an annuity unless the recommendation is suitable, and if the agent or supervising agency breaks the rules, they can both lose their licenses. The proposed changes affect both new sales and exchanges.
Meanwhile, in June 2009, the Financial Industry Regulatory Authority issued Notice 09-32. This specifically targets VA exchanges, reiterating changes it made to Rule 2821, which were approved by the Securities and Exchange Commission in April 2009. These changes raise the bar, and amount of paperwork required, to prove a suitable VA exchange is happening.
The FINRA changes say broker-dealers must take special notice in situations where a VA with an existing surrender charge is swapped for a VA with a new surrender charge, or if the consumer has had another VA exchange within the last three years. The B-D has seven days after receipt of the paperwork to accept or reject the exchange.
Both the NAIC and FINRA initiatives increase supervisory responsibility. NAIC’s proposal would finally be telling agents that they can lose their license for unsuitable fixed annuity sales, and telling marketing organizations that they had better supervise their agents, or else. FINRA’s Notice is sending a strong message to B-Ds that VA exchanges will be closely watched.
Neither the NAIC nor FINRA amendments are currently active. The NAIC changes need to be adopted and then implemented by the states. FINRA’s change goes into effect February 2010.
GLWBs and other riders. Guaranteed lifetime withdrawal benefits, also known under several other names, blossomed in the VA and fixed indexed annuity worlds in recent years. Today’s strained market conditions caused some carriers to pull or lessen the benefits, but based on my conversations, I believe they will stay around and grow.
Today’s popular annuity riders are guaranteeing income growth of 6%, 7% or 8% a year. This will make it difficult to leave an existing policy, especially if both future interest rates and the stock market are lackluster.
An annuity owner who at age 55 deposits $100,000 into an annuity that guarantees a 7% compound growth factor could be guaranteed $9,835 a year for life at age 65, at a 5% payout rate. However, if the annuity actually grows at 4% a year, the cash available before charges would be $148,024 at age 65; this means that the man would get a $7,401 yearly income if he now exchanges his original annuity to a new annuity paying the same 5% payout rate. To get the same income as the original annuity’s guaranteed $9,835 a year, the man would need either a 33% bonus on the new annuity value or a 6.6% guarantee on the new annuity payout.
For that reason, guaranteed lifetime income growth makes staying put more attractive and lessens the attraction of a 5% or 10% premium bonus. It places the focus on the bigger picture of retirement income.
In addition, annuities will continue to offer a greater variety of long term care benefits and riders. In conjunction with GLWBs, these features often require a three- to five-year waiting period before they may be used.
For the consumer, a 1035 exchange between annuities having such features could mean starting the LTC benefit clock all over again. These riders therefore give the existing annuity carrier a big benefit in the hand to offset the competitor’s promised one in the bush.
Installment commissions. In May 2009, two indexed annuity carriers announced that producers would have to wait a year or two for a share of their commission. The reason given was to reduce capital strain. This change will do that. It also makes a lot of long-term sense.
All annuities tend to pay the commission upfront. The problem on the fixed/indexed side is, this leaves less money on the table for carriers to buy bonds and thus generates less money down the road for future rates.
The problem for all is the agent has no further incentive to keep the business at the carrier. All annuity carriers have at various times tried to pay commissions over time instead of all upfront, but agents balked.
This time it may be different, though, because difficult capital markets and greater attention to profitability (instead of sales) seem to be encouraging carriers to hold the line. In addition, the new annuity commission schedules that are coming out still provide a decent upfront commission, but they’ve made the “installment plan” option much more attractive.
A regulatory environment more hostile to annuity exchanges, living benefits that are guaranteed to grow over time, and a commission structure that more closely aligns the agent’s pocketbook with the annuity owner’s will all work to reduce annuity exchanges. The greatest downward impact on overall sales should be felt in the VA world, but all annuity producers will be affected.
Jack Marrion is president of Advantage Compendium, Ltd., a St. Louis based research and consulting firm. His e-mail address is [email protected].