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Great Expectations

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By the end of 2011, annuities had continued their reign as the single largest segment of the life and health industry, amounting for nearly half of all revenue. Accident and health insurance came in a distant second, accounting for nearly 25% of all L&H revenue. Life insurance came in third, just behind accident and health, at just under 25% of total revenue. And while annuities have been the dominant sector in L&H for years, there are still key challenges to overcome if 2012 is to be a year of continued success.

According to Ernst & Young’s Global Outlook Center, the annuities industry needs to wrangle a host of challenges to make the best of 2012, from low interest rates, to uncertain regulations, the need to make better use of customer analytics, changes in the tax code, and incorporating social media into sales and lead generation.

By the end of the year, annuities companies can look back and see how well they succeeded at these challenges, but for now, where do they stand, what are their greatest triumphs, their biggest problems, and the toughest challenges yet to face? With so much riding on annuities as a block of business, insurers are already considering the good, bad and ugly details of this sector and what it portends for the coming year.


According to a series of reports at the end of 2011, annuities finished the year on a fairly strong note, at least at first glance.

According to SNL Financial LC, annuity considerations (periodic payments or one lump sum payment made to purchase an annuity plan) increased by 14.72% across the first three quarters of 2011 compared to the same period one year earlier. Total annuity considerations for the year topped $90 billion, which includes ordinary and group annuities as well as first-year, single and renewal considerations of U.S. life insurers for the nine months ended Sept. 30.

MetLife Inc., New York, and ING Group N.V., Amsterdam, Netherlands, which each saw annuity consideration grow more than 40%, logged market share increases of 323 and 105 basis points, respectively, SNL says. The top five insurers have a combined market share of 40.65% for the nine months ended Sept. 30, compared to 36.06% for the prior-year period.

Prudential Financial Inc. and Manulife Financial Corp. saw market share decreases of 85 and 103 basis points, respectively. Manulife previously indicated that declines in annuity considerations were expected, leading to its market share decrease. Prudential has enjoyed an annuity considerations increase of 4.92%, but this was lower than the increases among the other top five insurers.

Of special interest to the sector are annuity sales through financial institutions, which increased nearly 11% in the third quarter of 2011 compared to the comparable period one year ago. This comes from a report by Lehrer-LIMRA, a subsidiary of LIMRA Services, Windsor, Conn. The report itself is a summary of results from its monthly bank annuity sales survey, based on a national sample of banks that have a minimum of $4 billion in assets. The participating institutions account for about one-third of all bank annuity sales.

The survey reports that bank annuity sales increased to $9.2 billion in third quarter from $8.3 billion in the third of 2010, a 10.8% rise. The third quarter figure is, however, down from the $10.1 billion recorded in the second quarter of 2011.

Likewise, variable annuity sales through financial institutions in the third quarter totaled $5.2 billion, up 24% from the $4.2 billion posted in the third quarter of 2010. Fixed annuity sales through banks topped out at $4.0 billion in the quarter, a 5% decline from the same period a year ago.

The Kehrer-LIMRA report also shows the average effective yield on bank fixed annuities at 1.24% as of September 15, below the average 5-year CD rates of 1.34%. This compares with an average effective yield and average 5-year CD rate of 1.61% and 1.71% respectively, for the same period one year ago.

Despite these drops, the American Bankers Insurance Associated reported that during the first three quarters of 2011, income earned from the sale of annuities at bank holding companies climbed 22.6%. ABIA’s report, based on data from all 6,740 commercial and FDIC-supervised savings banks and 927 large top-tier bank holding companies operating on September 30, 2011, revealed that annuity income from the sale of annuities at bank holding companies in the first three quarters of the year rose from 1.84 billion in 2010 to $2.26 billion 2011.

Third-quarter BHC annuity commissions were $731.5 million, down 6.4% from a record-setting $781.4 million in second quarter 2011, but still up 17.7% from $621.3 million earned in third quarter 2010. Slightly more than 40% of large, top-tier BHCs engaged in annuity sales in 2011, and their $2.26 billion in annuity commissions and fees constituted 12% of their total mutual fund and annuity income of $18.91 billion and 16% of total BHC insurance sales volume (i.e., the sum of annuity and insurance brokerage income) of $14.2 billion.

Of the 6,740 banks, 901 or 13.4% participated in annuity sales activities, earning $588.9 million in annuity commissions or 26.0% of the banking industry’s total annuity fee income. Bank annuity production was up 5% from $560.9 million in the first three quarters of 2010.

Three-quarters (75.3%) of BHCs with over $10 billion in assets earned third quarter year-to-date annuity commissions of $2.15 billion, constituting 95% of total annuity commissions reported. This was an increase of 23.7% from $1.74 billion in annuity fee income in the first three quarters of 2010.

Among this asset class of largest BHCs in the first three quarters, annuity commissions made up 11.5% of their total mutual fund and annuity income of $18.60 billion and 15.9 %of their total insurance sales volume of $13.51 billion. Wells Fargo & Company (CA), Morgan Stanley (NY), JPMorgan Chase & Co. (NY), Bank of America Corporation (NC), and Regions Financial Corp. (AL) led all bank holding companies in annuity commission income in the first three quarters of 2011.

Meanwhile, a report from research firm Hearts & Wallets LLC, Hingham, Mass., found that investors who use an insurer as their primary firm invest nearly 20% of assets in annuities.

The quantitative survey of more than 4,500 U.S. savers is a representative sampling of the U.S. population. The report also found that investors who use a bank as their primary provider invest nearly half of their assets in bank products, such as certificates of deposit, FDIC savings or checking accounts.

Among the report’s other findings:

  1. 46% of investors who have $500,000 or more in investable assets hold annuities.
  2. Nearly half of investors ages 21-27 say they don’t own investment products.
  3. 33% of fully employed seniors own annuities, a percentage higher than that of all other age groups.
  4. Average annuity allocation grew to 12% in 2011 from 9% percent in 2008 among high-net worth pre/post retirees.
  5. About one-third (29%) of pre/post-retirees own annuities. Those who own them invest about one-fifth (21%) of their assets in annuities.
  6. More than a quarter of pre/post-retirees who do not currently own an annuity or individual bond are interested in these potential income-producing products. The most important time for product trials is among younger investors, such as Accumulators, ages 20s through 50s.

Not surprisingly, a number of companies have rolled out new annuity products in recent months:

Securian Financial Group, St. Paul, Minn. debuted SecureOption Focus, a fixed deferred annuity that offers a choice of initial guarantee periods, a return of premium guarantee and a bonus interest rate in the one-year guarantee period.

Pacific Life Insurance Co., Newport Beach, Calif., released an optional withdrawal benefit in Pacific Life’s Pacific Index Choice deferred fixed indexed annuity. The new Enhanced Lifetime Income Benefit lets policyholders increase retirement income whether or not the product earns interest.

Pacific Life Insurance Company also launched a variable annuity, Pacific Destinations O-Series, that offers the low mortality, expense, and administrative fees of an A-share product without an up-front sales charge. The product features four investment asset allocation categories. For an additional cost, two optional guaranteed withdrawal benefits: Automatic Income Builder, which lets clients receive income for life with automatic increases; and CoreIncome Advantage5 Plus, which can lock in market gains and an income that can continue for life.

At the same time, Pacific life also rolled out Pacific Index Choice, a deferred, fixed indexed annuity that offers index-linked options for earning interest based on the movement of either the S&P 500 index or the MSCI All Country World Index, which encompasses 45 developed and emerging markets. When the index rises, the account earns interest. Should the index fall, there is no loss of contract value.

Midland National Life Insurance Co. (West Des Moines, Iowa) has released a new fixed index annuity, MNL RetireVantage, which can link to price of gold and pay partial interest credits at the date of death. The annuity also offers an Additional Benefit Rider that can pay holders a premium bonus, an additional annuity payout benefit, an increased penalty-free withdrawal allowance and return of premium.

The U.S. Retirement Division of ING North America Insurance Corp. (Windsor, Conn.) unveiled a new asset allocation program to help 401(k) plan participants convert their savings over time into a guaranteed lifetime stream of income.

Western & Southern Financial Group (Cincinnati, Ohio) and Mid Atlantic Capital Group Inc. (Pittsburgh, Pa.) finalized their formal filing with the U.S. Patent and Trademark Office on the key business methods underpinning VAROOM, a variable annuity launched in Jan. 2011 offering subaccount options that invest in individual exchange-traded funds (ETFs).

Genworth Financial, Inc., Richmond, Va. launched two new index annuities. Dubbed SecureLiving Index 7 and SecureLiving Index 10 Plus, the products will be issued by Genworth Life and Annuity Insurance Company. Genworth says the single-premium, fixed deferred annuities offer index-based and fixed interest crediting strategies. Consumers can allocate premium across five crediting strategies based on individual needs and risk tolerances.

W&S Financial Group Distributors, Inc., Cincinnati, the wholesale distributor of annuities and life insurance from Western & Southern Financial Group launched MultiVantage, a single-premium deferred annuity with a market value adjustment (MVA). The product features, among other things, minimum guaranteed rate for the life of the contract, guaranteed lifetime income and the ability to withdraw up to 10% of the account value (noncumulative) each contract year with no withdrawal charge or MVA.

Jefferson National Life Insurance Co., Dallas, Tex., added 23 new investment options from TOPS, Virtus, BlackRock PIMCO and Oppenheimer Funds to its Monument Advisor flat-fee variable annuity.


It is not all good news, however. That $90 billion that went into annuities last year? It was more than offset by annuity outflows (the products redeemed more than the amount invested). Last November, net cash flows went down by 2.5%, from $1.9 billion to $1.84 billion. For the full year, 700 annuity products had positive net flows. A whopping 2,450 annuity products did not.

Variable annuities assets dipped nearly 5% in value in the third quarter of 2011 compared to the same period one year ago, according to a survey by Strategic Insight, Arlington, Va., which noted that variable annuity funds (excluding fixed accounts) totaled $1,235 billion at the end of September, down from $1,297 billion at the close of the third quarter of 2010.

In relation to the second quarter, the third quarter dip was even greater: down 12.7% when assets were $1,415 billion.

The survey notes also that equities experienced a net outflow of funds totaling $19.3 billion at the end of September. This compares with a net outflow totaling $1.7 billion in the third quarter of 2010.

Equity funds totaled $879.9 billion of $1.2 trillion in variable assets (including bonds and money market funds) in the third quarter of 2011, or 71.3% of the total. This contrasts with $963.3 billion of $1.3 trillion in assets, or 74.3% of the total, for the year-ago period.

Bond funds rose to 24.6% ($303.5 billion) of assets in the third quarter from 21.8% ($282.6 billion) in the third quarter of 2010. Money market assets rose marginally 4.2% ($51.5 billion) in September from 3.9% ($51 billion) for the year-ago period.

Of special interest is the fate of ING Group, N.V., Amsterdam, Netherlands, which took earnings charge against the fourth quarter 2011 results of its U.S. closed variable annuity block of business. The adjustment included a charge to restore the reserve adequacy for a block of variable annuity policies it stopped selling in 2009. Since then, the Group has been reducing deferred acquisition costs, strengthening reserves, expanding hedging program and increasing transparency by reporting the closed U.S. VA block as a separate business along the ongoing ING insurance U.S. businesses.

Following the announcement of the earnings charge, Moody’s Investors Service, New York, downgraded ING to A3 from A2 the insurance financial strength (IFS) ratings of ING USA Annuity and Life Insurance Company and its rated US life insurance affiliates (collectively, ING US). The outlook on these ratings is stable.

Commenting on the downgrade, Moody’s said that the reserve charge was sizable relative to ING US’s earnings and capital and weakened the US operation’s standalone credit quality. Moody’s added that some support for the U.S. operations to offset the reserve charge may come from the wider ING Group.

“Although ING US has largely exited the business, charges related to legacy VA policies continue to depress the group’s overall profitability and weaken capital adequacy, thereby delaying its recovery” says Laura Bazer, vice president and senior credit officer. “Moreover, greater policyholder efficiency in capturing the value of their guaranteed benefits may be the source of future charges.”

Separately, Bazer adds, the U.S. group faced the challenge and uncertainties of separating from its parent company, particularly in terms of establishing reliable and cost-effective stand-alone financing arrangements, as it moves toward its planned IPO in 2012.

The ING announcement came on the heels of another insurer, John Hancock, announcing that it would be limiting its annuity exposure, mainly as a result of the current economic environment.

John Hancock discontinued its Venture 7 series, 4 series and Frontier variable annuities. Of its market-value-adjusted annuities, it withdrew its JH Signature, JH Choice and Inflation Guard annuities. It also ended its Essential Income Immediate Annuity. John Hancock accepted new business on the discontinued annuities until Dec. 16.

John Hancock is owned by a Canadian insurer, Manulife Financial. Because of Hancock’s annuity-related losses, Manulife announced a $900 million charge. Not long after, the discontinuations were announced. This came as little surprise for many, as Canadian companies are held to stricter accounting standards than their American counterparts, and after Hancock’s annuity losses, the company had to stop the bleeding. But it was hardly the only one.

In early December, Sun Life Financial Inc., Toronto, (NYSE: SLF), disclosed its decision to halt sales of its domestic U.S. variable annuity and individual life products effective December 30. The decision follows completion of a strategic review of the company’s businesses and a desire to improve returns on shareholders’ equity and reduce volatility.

Sun Life says the strategic repositioning should not materially impact its 2012 operating net income. (In November, Sun Life recorded an operating loss of $572 million (CDN) for the third quarter of 2011, compared with operating net income of $403 million in the same period last year.)

The estimated one-time transition cost associated with the discontinuation of these products is approximately $75 to $100 million on a pre-tax basis, a portion of which will be recorded in the fourth quarter of 2011, with the remainder expected to be charged to income in 2012.

In addition, as of September 30, 2011, Sun Life has $97 million of goodwill associated with variable annuity business in SLF U.S., which the company says will be reviewed and likely written down as part of the company’s decision to discontinue sales of the product.

The exit of players such as ING, John Hancock and Sun Life is merely part of a larger trend that industry-watchers expect to continue. As long as there is volatility in the equity markers and low Treasury rates, insurers will continue to feel the pain on their annuities business. For many, their losses have been unsustainable, and for some companies, pulling back on their annuities business is not a matter of if, but a matter of when.

According to a report by Moody’s Laura Bazer, the key thing is that policyholders are becoming more informed about their complex insurance policies, and are acting to gain the value of guaranteed insurance benefits when they are “in the money.”

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In pricing and hedging the risks of their VA contracts, companies must also make assumptions about how many customers will hold on to their policies long enough to be eligible for benefit, how many of them will exercise guaranteed benefit options when they become available and how many more of them may exercise those options, the report explains.

If the company’s assumptions underestimate how aware customers are in timing and making these decisions, Bazer explains, there can be significant unexpected additional economic costs to the company.

With ING, VA policyholders were found to be holding on to their policies longer, and in greater numbers than ING originally assumed. ING had to increase its reserves to reflect the larger number of policyholders that may ultimately receive benefits over the life of their contracts.

Moody’s noted that the Netherlands-based ING is not alone in taking charges for policyholders behaving differently than the insurer expected. Manulife and Sun Life both took large after-tax charges for lapsation and other behavior assumption charges on its U.S. annuities business.

U.S. players such as Prudential Financial have also taken charges in recent quarters, even if they are less visible to investors, Bazer said.

Andrew Kligerman, a life insurance analyst at UBS AG, says that companies such as Lincoln National, Hartford Life, AIG and other sellers of VAs with guaranteed benefits have done an adequate job of reserving, but he remains concerned that the returns for this product in general may not be adequate.

If companies fully hedge the assumptions for these products, the returns are anywhere between 0% and 5%, he said, noting that today, volatility and interest rate hedging costs are different than what they would be in more historic scenarios. While the trade group for life insurers declined to comment, the issue is on the radar of U.S. companies, and some hold that there may be over, not under,- reserving on the U.S. side for these products.

U.S. statutory reserves for variable annuities are based on Actuarial Guideline 43, and there might be different issues there with reserves at companies than with their Canadian counterparts, though.

MetLife’s CEO Steve Kandarian stated on a third-quarter conference call that it would continue to make adjustments in some of its guaranteed benefit products.

“While we are comfortable with the pricing and returns on our third-quarter VA sales, we continue to seek opportunities to re-price and improve the risk profile of our product offerings. As of January, the rollup rate on our GMIB Max product will be reduced from 5.5% to 5%. We are closely monitoring sales and if they rise above plan, there are steps we can take and will take to bring sales in line. As a matter of sound capital management, we will only pursue growth that we believe maximizes long-term shareholder value,” Kandarian stated on the 3Q call.

Kandarian and his colleagues will have to. Going by LIMRA figures, nearly 9 out of 10 variable annuity buyers elected to purchase a guaranteed living benefit rider in the third quarter of 2011, according to a new report that collects VA GLB sales, election rates and assets on a quarterly basis. The 23 survey participants represent 96% of third quarter 2011 industry sales in which a GLB was elected.

The survey reports that 88% of VA sales ($25.2 billion) included a GLB rider on products offering the rider ($28.7 billion in sales). Total VA sales in the third quarter were $31.5 billion. The bleeding, as it were, looks like it may only have just begun.



Concerns over the financial sustainability of annuities is not entirely new, and despite them, there are still plenty of companies that see far more upside than downside to the sector. Fair enough. But one front that is causing concern is the possible regulatory oversight on contingent deferred annuities, a relatively new product that works essentially as a group contract as part of an employer-sponsored retirement plan, and one in which the insurer does not actually hold the assets underpinning the annuity.

Specifically, the products enable the use of existing accumulated assets for guaranteed lifetime income without requiring policyholders to transfer their assets to an insurance company. For this reason, there has been some concern by some companies and regulators that the products are not even annuities, but instead are financial guaranty products.

The NAIC’s Contingent Deferred Annuity Subgroup (CDAS) of the Life Insurance and Annuities (A) Committee is considering the nature of these financial products, which many in the insurance industry and in the regulatory arena believe can be a valuable product for those who are concerned that they will outlive their assets.

Contingent annuities function in a very similar manner to products with guaranteed lifetime withdrawal benefit (GLWB), with the basic framework already in place at the state level for them to be regulated as annuity products, according to a report by the American Academy of Actuaries (AAA) during a recent NAIC teleconference.

The AAA analysis by its Contingent Annuity Work Group (CAWG) sought to clarify this issue by noting that financial guaranty insurance products, like bond insurance, protect against specific types of financial losses and contain no life contingent element. Life annuities, on the other hand, protect for a lifetime and protect against outliving one’s assets, and contain a life contingent element, the AAA noted, so the product is a longevity protection product.

The AAA did hold that contingent annuity covered assets differ from those of GLWBs because they are external to the life insurance company. GLWBs provide guaranteed lifetime income based on the value of insurance company held assets. Furthermore, the relationship between market performance and contingent annuity payments is indirect.

The regulatory framework that is already in place includes most states’ adherence to the NAIC models for reserves and capital for GLWBs and all states’ existing procedures for approval of GLWBs, according to the AAA report, and any differences and similarities to GLWBs should be disclosed in product filings, the AAA advised the NAIC.

The statutory reserve guidelines for CDAs or CAs are the same as for GLWBs and are addressed under Actuarial Guideline 43, (AG 43) the statutory risk-based capital requirements for contingent annuities are also addressed by current requirements and both are generally risk-managed through capital markets hedging programs by life insurers, the AAA pointed out.

The issue, which came to a fore at the NAIC fall meeting, divided some, even as most agreed the product is valuable for consumers.

A contingent annuity is essentially a stand-alone guaranteed living withdrawal benefit, Olsen had told regulators at the NAIC Fall meeting.

The AAA working group also looked at an IRS tax treatment, a Securities and Exchange Commission (SEC) treatment, a non-forfeiture treatment, as well as state guaranty fund coverages to reach its conclusions.

In several private letter rulings, the IRS ruled that CAs are considered annuities for tax purposes and at the SEC, CAs, like GLWBs, are generally registered as securities (except for certain qualified retirement plans), the AAA pointed out.

“The product had a material longevity component, and the life industry has the experience to manage these risks,” Olsen said.

It is believed that the NAIC has to come out with a position either way, so there isn’t a lack of uniformity on this issue from state-to-state.

New Jersey leads the CDAS and believes the product is a hybrid. However, a hybrid position would likely need its own new NAIC model.

New Jersey is home to Prudential Insurance, of course, one of the supporters of CDAs as straight annuity products. Business rival and usual regulatory ally MetLife is one of the companies that is against the annuity classification.

This is the first time in my career, both in industry and as a regulator, where I’ve seen Met and Pru so diametrically opposed on a core insurance/annuity issue,” New Jersey Commissioner of Banking and Insurance Tom Considine told National Underwriter.

The AAA’s own contingent annuities working group compared key risks and benefits of a contingent annuity to those of the widely accepted variable annuities with guaranteed living withdrawal benefits.

Prudential Financial, in New Jersey, publicly supported the AAA working group’s analysis back in November, noting the product does not “indemnify loss.”

Mark Birdsall, the influential Kansas Insurance Department actuary, has expressed reservations, however.

“We reviewed a product similar to what is being described here – we determined this product structure does not fit the current regulatory structure,” while it may be in the public interest, Birdsall said at the NAIC Fall meeting.

MetLife will not be selling the product, according to Eric DuPont of the New York-domiciled company, speaking at the Fall meeting. In fact, MetLife does not think the product is even an annuity, and that it could lead to reserve problems. And New York does not take lightly to reserve issues generated from a financial product.

“Among MetLife’s concerns is that we believe it is very difficult to measure and manage the risk associated with the guaranty on a contingent annuity. Therefore, it is difficult to determine adequate reserving needed to support the product,” Dupont stated.

Moreover, DuPont noted that the then- New York Insurance Department (now the combined Department of Financial Services) asserted in 2009 that contingent annuities are financial guaranty insurance under New York law.

The New York law the DFS referenced follows the NAIC’s Financial Guaranty Insurance Model Law. That October 2008 contains a lengthy definition of financial guarantee insurance.

In its report, the AAA did caution that contingent annuities risks to life insurance companies demand strong, comprehensive risk management practices by the life insurer and appropriate regulatory oversight by the state.

On a separate NAIC conference call in late January, the issue arose once again, this time by way of whether the products would be covered by state guaranty funds if the insurers selling them failed.

Whether or not the products are covered by guaranty funds will take years to resolve, Felix Schirripa, chief actuary with the New Jersey Department of Banking and Insurance said on the call.

Schirripa did say that the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA), voluntary association made up of the life and health insurance guaranty associations of all 50 states, the District of Columbia, and Puerto Rico, is looking into CDA consideration.

Birny Birnbaum of the Center for Economic Justice said on the call that just because there is a demand for CDAs in the marketplace, then that doesn’t mean it is appropriate, legal or reasonable to sell them as annuities, echoing MetLife’s entrenched stance on the issue.

Birnbaum, a consumer advocate and economist, said that a CDA seems to him to be a derivative type of product which leverages the risk to insurers, and that it is really essential not to find out how much product is already out in the marketplace, how much exposure insurers are facing and also if guaranty fund coverage is indeed available for them.

Prudential’s representative said on the call that the company would not want these products to create any concerns echoed by some, and that the company is a proponent of appropriate regulatory guidance and oversight as a way to reduce risk.

To be sure, there is some element of market risk that exists with respect to CDAs, Prudential stated, but kept noting the products cover longevity risk, the hallmark of an annuity product.

But Schirripa was also concerned about fee drag, causing a reduction in available funds. He said he thinks buyers need to know that, the possibility of forfeiting lifetime income if they need access to the funds, and the possibility of meaningful longevity protection mostly when moved to a higher risk, higher reward portfolio. Retirees should be encouraged with these products to move out of low-yield investments, the actuary said.

Schirripa said he sees the possibility of meaningful longevity protection if retirees moved to a higher risk, higher reward portfolio. However, at the outset of the call, Schirripa made clear that the group has a common goal, helping retirees and near retirees optimize their retirement savings–that is the goal, and that although there are tough questions, the NAIC subgroup has not prejudged CDAs.

That said, the fate of CDAs remains uncertain, and until it is resolved, it remains a complicating element in the never-dull annuities market.  

Allison Bell, Warren S. Hersch, Michael K. Stanley and Elizabeth Festa contributed to this report. This report also contains content originally written by Maria Wood and Danielle Andrus, and published on the portal.