Low interest rates and stress-inducing market upheavals can make any investor, especially those nearing retirement, a bit shell–shocked. But there may be a cure. According to report from Conning Research & Consulting, indexed annuities are positioned for growthif carriers meet certain headwinds.

Scott Hawkins, (below right) vice president of insurance research and consulting for Conning in Hartford, Conn., recently authored a study entitled, “Indexed Annuities: New Growth Opportunities.” The report details the opportunities and challenges index annuity providers face.

The Opportunities

According to Conning’s research, the number of potential annuity customers swelled in the past decade, yet insurers barely made a dent in reaching that sector. At the same time, market penetration by mutual funds grew.

Looking at population growth between 2005 through 2010, Conning researchers calculated that by the end of 2010, there could have been roughly 40.6 million annuity contracts in force. Yet the actual number was 32 million, “representing a possible $600 million in additional assets” under management, Conning concludes.

If the sheer number of prospective customers isn’t tantalizing enough for annuity carriers, then current market condition are prime for a product like indexed annuities, says Hawkins, who spoke recently with LifeHealthPro.com.

Low interest rates make traditional fixed annuities less attractive, and more conservative investors would rather see their accumulated retirement assets sheltered than battered in an equity market-based variable annuity, Hawkins says.

Therefore, consumers looking for a better than fixed interest rate return yet with less exposure to downside risk would gravitate toward indexed annuities, Hawkins says.

Many indexed annuities have also taken a page from variable annuities (VAs) and now offer guaranteed living withdrawal benefits (GLWB).

“That’s important because as we baby boomers start to get closer to retirement or enter our retirement phases, how we generate retirement income is increasingly important,” Hawkins says, “The GLWB is certainly an option that an investor might want to consider and so the product itself has become a bit more appealing relative to where it was five to six years ago.”

The Challenges

The challenge for indexed annuity providers boils down to one phrase: investment risk management, Hawkins says. That includes “both the hedging program needed to generate the index linked returns as well as managing the general account portfolios in the low interest rate environment,” he explains.

To uncover how annuity providers manage investment risk, Hawkins studied how the general account portfolios of the top five index annuity providers, VA players and traditional fixed annuity insurers changed between 2005 and 2010. What he found was that even before the 2008 economic crisis hit, indexed annuity providers were taking steps to increase ROI.

The indexed annuity providers, more so than their VA or fixed annuity counterparts, had shifted away from U.S. government bonds toward corporates as a way to increase yield, Hawkins states.

And “they went longer in duration; again, as a way to increase yield, more so than the other two groups,” he says. “What’s interesting is that they were starting to make those changes before the 2008 crisis, so they were already trying to figure out ways to perhaps increase their overall portfolio yields starting before this low interest rate environment hit.”

From a product perspective, providers can and have adjusted caps to “try to maintain some kind of profitability in the pricing that way,” Hawkins continues.

Yet, as the study points out, since indexed annuity providers use hedging to generate income, “they use significantly more equity/indexed hedging.” Because of that, “indexed annuity insurers may be subject to greater volatility in investment income than traditional fixed annuity or VA insurers are.”

A second challenge is simply getting distributors and consumers to understand what is a complex product, particularly as it pertains to caps and crediting features.

“Indexed annuity players need to figure out ways to develop easy to understand consumer material as well as good distributor educational material and programs that will help the distributor, who ultimately has the relationship with the client, do a good job of explaining how it works,” Hawkins says.

Next week, Hawkins details new distribution channels and how they are impacting the industry.