Cheer up, annuity providers. In every down market, there is an upside. That’s the way Sam Friedman (below right), insurance leader, Deloitte Research, sees it. The New York City-based executive recently spoke to LifeHealthPro.com about the current and future state of the annuity industry.

First, he assesses the market’s dark side and agrees with nearly every observer that the current low interest rate environment is the biggest challenge facing annuity underwriters, especially those underwriting fixed annuities that carry guaranteed returns. For that reason, fixed annuity providers must be more resourceful when managing risk, which may include delving into alternative asset classes such corporates.

However, Friedman says, the rating agencies understand this and seem willing to cut the carriers some slack. He recalls talking to some rating agency folks about this topic at a recent Deloitte conference on enterprise risk management.

“Obviously, they are aware of the pressures that fixed annuity underwriters and annuity underwriters in general are under from an investment income standpoint with these volatile equity markets and such low interest rates,” he says. “The agencies recognize hedging strategies and alternative investment strategies are legitimate, that annuity writers are going to have to take on perhaps some additional risk in order to get the kind of return that is required to remain competitive. The tricky part is proving to the rating agency you are on top of this, that you are not being reckless in any way. The agencies are not looking to be a red light for these types of strategies, but they are serving as perhaps a bit of a speed bump to make sure the enterprise risk management system that’s in place is taking these kinds of risks into account.”

Better Times Ahead?

Yet there are signs pointing to better times ahead for annuity players. As the economy lurches toward recovery, the stock market will follow, which can only help the annuity industryalthough not all products will benefit to the same degree, Friedman says.

“Both corporations and individuals are sitting on a lot of cash right now,” he says. “So I think that sort of speaks to the fact that you are going to see a fairly decent stock market over the next couple of years. The volatility is going to be unsettling, particularly for individual investors. But theoretically institutional investors are better positioned to hedge and to ride these roller coaster rides out. But ultimately, if you look at the overall trend, short of another double dip recession, I think that investment managers for insurers and annuity companies will have opportunities to make money in the equities markets to offset some of this downside risk on interest[-rate] sensitive products.”

Pointing to the booming sales of variable annuities, Friedman contends that it doesn’t appear the currently chancy stock market is making these products any less attractive to consumers, and perhaps even better poised for growth than fixed annuities.

“Overall, variables are going to do better as opposed to fixed only because insurers are not going to be able to guarantee fixed annuities,” he explains. “With variables, there is more risk to the policyholder. It’s going to be interesting to see how that plays out in terms of being able to market the products. But right now, it doesn’t seem to be discouraging sales.”

Whether fixed or variable, an annuity could provide a better investment alternative than simply parking money in Treasuries and bonds and waiting for interest rates to tick up, Friedman says. “That’s going to be a while,” he says.

A Needed Product

Perhaps the strongest factor in favor of annuities is the desire by retirees and pre-retirees for guarantee income in their golden years, even if it means trading off some upside potential.

“With more and more baby boomers retiring, you just know in your gut when we get pass this election,” Friedman says, “Social Security is going to be tackled and the retirement age may be raised again, which is going to put pressure on individuals to try to find a way to bridge that gap between when they’d like to retire, maybe at age 60, 62, 63, and when Social Security might kick in, which could be anywhere from 67 to 70 or higher as reform plays out. Annuities can create a nice buffer there and can help hedge the risk that you might live beyond your assets.”

For that reason, annuities fill a legitimate, consumer-driven needalways a selling point for any product or service.

“It’s going to be a struggle for the next couple of years, no doubt about it,” Friedman says. “But ultimately, long term, there isn’t anything better out there to fulfill these needs for consumers. The players may change, companies may come in and out of markets, some may report better or lesser results in the short term but longer term it’s going to be a much brighter future for annuities.”