The financial upheaval of the last two years created major strains on insurance company financials that have taken 2008 and the better part of 2009 to address. Variable annuity carriers have not been immune, and many have revamped products accordingly. Soon, however, carriers will be able to offer a new type of annuity product that will help restore competitive advantage.
First, some background.
The upheaval resulting from decline in the capital markets and the unprecedented volatility seen in those markets created significant strain on earnings. That is actually a very generous statement. Many insurers, including the very largest and some of the most prestigious, lost billions on their VA businesses, and most if not all of them set up higher reserves.
Many companies needed to replenish their capital, lest they be considered insolvent, and some even received funds from the Troubled Assets Relief Program.
For many VA writers, the primary culprit has been their living benefit riders. These riders–whether guaranteed minimum withdrawal benefits, guaranteed minimum income benefits, or guaranteed minimum accumulation benefits–provide downside protection against market declines. They have driven the strong increase in VA sales over the last 8 years. Most carriers that did not have a competitive living benefit design suffered in terms of sales.
The financial debacle provided evidence that insurers were not themselves efficiently protected against downturns. While they were hedged, the costs of hedging were well in excess of pricing assumptions and were a major contributor in company losses.
For most companies, existing living benefit contract provisions preclude increasing charges on existing contract holders except in certain circumstances, so the focus has been to redesign current offerings to better reflect current market conditions. This led to a flow of “de-risking” changes, resulting in a wave of re-filings, especially in the first 4 months of 2009. De-risking has included both more limited benefits and product features and higher charges.
For quite a few VA contracts, the total going-in expenses, including mortality and expense risk charges, administrative charges, rider charges, and investment expenses, have totaled over 350 basis points. In some cases, companies have made the strategic decision to exit the living benefits arena entirely, a reflection of their discomfort with the whole living benefits risk. In other cases, companies have chosen to deemphasize the living benefit risk while still offering it. For them, the living benefit had become too much the tail wagging the dog.
Not too long ago, companies preached the mantra that any going-in product charges over 300 bps would be anathema to the distributor and client. One may ask why this point of view is no longer valid. After all, in a more constrained economy, with many investors still seeing major hits to their retirement portfolios, why are higher costs for an annuity now more acceptable? That doesn’t necessarily hold together under pressure of analysis and heightened consumer scrutiny.
VA costs have always been a hotly criticized topic, and the new VA products’ increase in costs for reduced benefits may have an adverse impact on the market. It is not surprising, then, that some companies have responded to the higher cost concern by simplifying the product (reducing benefits), reducing compensation, and delivering a lower cost product.
A secondary trend in today’s VAs is the move to offering more “passive” investments from actively managed ones and applying tighter restrictions on investment selection. The passive investments, whether indexed funds or baskets of exchange traded funds, have lower investment expenses than do more conventional portfolio manager-driven funds.
What does this all mean? Limited product design, pricier benefits, reduced compensation, and limited investment selection, while not always applicable, do not augur well for sales and distinguishing one’s offerings from the competition.
How can carriers develop a competitive advantage in such an environment? They can make achieving competitive advantage a major corporate objective. Now more than ever, companies need to break away from the pack of diluted and more expensive offerings.
Given current VA pricing, any successful add-on offering will need to be of modest cost. After all, many clients simply won’t be able to afford pricey offerings. Also, given the projected low stock market returns for the foreseeable future, large expenses will drag down returns even further.
Combination annuity/long term care products are a great fit with today’s new reality. Here is why: The cost for the LTC coverage is very modest (e.g., at age 65, the cost would be $2,500 for a stand-alone LTC policy compared to about $600-$700 for a LTC rider in an annuity). Also, the non-investment orientation should appeal to insurers with a senior management mandate to limit investment risk.
Further, the favorable treatment of such products, under tax law that becomes effective on January 1, 2010, provides clients with a great alternative to costly standalone LTC products. Finally, market demographics confirm the enormous size of the target market segment.
The presence of combination annuity/LTC products in a VA portfolio can provide insurers with a compelling competitive advantage and potentially substantial sales growth. Given where VA sales are today, combining annuities and LTC could be a welcome way to diversify risk, while increasing annuities’ appeal to producers and customers.
Cary Lakenbach, FSA, MAAA, CLU, is president of Actuarial Strategies, Inc., Bloomfield, Conn. E-mail him at [email protected]