I was a bit surprised when I checked out industry data from the Insurance Information Institute earlier this year that had pegged industry earnings for 2010, because for the first time that I can remember, life insurance became the smallest sector in this business. Annuities came in with nearly half of total industry revenue, health insurance came in at just over a quarter, and life insurance picked up the rest, as just under a quarter. I found myself thinking that we often refer to this as the life and health insurance industry, but in reality, we ought to call it the annuity, health & life insurance industry. And even though health and life may jockey places over the next coming years, neither can hold a candle to annuities, which have become the heart and soul of this business.
Annuities, as I like to describe to my friends, are like a do-it-yourself pensions. And as a recent article by Linda Koco points out, that’s pretty much how the U.S. Government Accountability Office likes to think of them, too. In fact, they went so far as to suggest that with programs like Social Security increasingly being seen as a potentially unreliable form of retirement funding (ask anybody under 40 if they think they’ll ever collect on Social Security, and you’ll see what I mean), annuities might be the best bet for Americans to successfully cash in on the new American Dream: a long and financially comfortable retirement.
This is easy to sell to. After all, everybody wants to make it to retirement. Most of us imagine that we will certainly live that long, and when hit with the notion that whatever we save, coupled with Social Security (if it’s even there) won’t be enough to sustain us, the thought of dropping a ton of money into annuities becomes pretty compelling. Certainly, it is an easier conversation to have with people who would rather not talk about dying prematurely, let alone buy additional coverage against it.
And so we find ourselves in an industry that is more devoted to retirement funding than anything else. There is nothing wrong with this. It is where the money is at for the current distribution system, and as the first Boomers turn 65, we are on the cusp of seeing a wave of retirement the likes of which modern America has never seen. And that is the scary part.
It is scary because for years, the industry has been selling annuities hand over fist, but it has never really had to pay for their guaranteed benefits at a level it will have to increasingly live by over the next decade and beyond. I had lunch with some asset managers for the insurance industry yesterday, and when I put this conundrum to them – can the life insurance industry really afford to pay out on all of the annuities it is selling? – the answer was not one you want to hear.
My lunch partners felt that there is a growing gap between the industry’s long-tail liabilities (namely annuity guarantees) and its ability to pay for them. Income is simply not growing fast enough to match the rate at which liabilities are growing. Portfolios are not performing strongly enough, and insurance sales certainly are not at a level to pick up the slack, so the industry must get creative – and do it soon – before it finds itself in a slow-motion march over a financial cliff.
We are already seeing this in other markets. In Asia, insurers there increasingly realize that they are already stuck between a rock and a hard place. Interest rates have been abysmal there for a long time, there is not a huge amount of liquidity in that market, a shallow bond market and right restrictions on where companies can invest in the global marketplace. There does not appear to be a clear solution there, but the upshot I was given was that the European market is beginning to feel the same pressures. The American market will be the last to feel them too, but rest assured, it will.
The good news is that carriers seem to not have their heads in the sand on this issue, and it would seem that if any area of the industry could fix this problem, it would be in the United States, where despite Dodd-Frank and everything else, this is still a relatively open market in which to get creative with risk financing. The industry’s best and brightest minds are no doubt working hard on a solution that will enable the industry to keep selling annuities as fast as it can sign off on them while still being able to live up to its customer promises before the entire system comes screeching to a halt.
And while I have faith that the industry will indeed find a way out of this, I do have a piece of advice: work faster. There is less time on this than any of us would care to admit.