Are you ready carriers, insurance agents and advisors? You’ll want to be on the front lines of the next big boom in the industry—ANNUITIES are poised to take a big bite out of the retirement income pie—but there are risks as well as rewards.
The rewards in terms of revenue generation and returns are potentially large and lucrative. But before anyone takes a bigger dip into the retirement income well, beware. Risks lurk in many corners. For insurers, the stakes involve concocting sophisticated hedging strategies to combat a volatile equity market and low interest rates as well as ever-present regulatory scrutiny.
For advisors, they face a skeptical public soured on financial products in general and annuities in particular.
But for carriers that can meet those challenges and advisors who can market annuities properly, the growing retirement income market is ripe for the taking.
The opportunity of a lifetime
There is some $9.5 trillion sitting either in IRAs, defined contribution plans or non-qualified mutual funds that may soon be looking for an investment option that provides a lifetime of guaranteed income. And annuity insurers are well-positioned to capture that burgeoning market, says a new report by Conning Research & Consulting, “The Big Payout: Growing Individual Retirement Income Opportunities.”
Breaking down the numbers further, Conning estimates that individual and group annuities accounted for 46 percent of all defined contribution (DC) plan assets as of the end of 2011. A nice percentage, but Conning says there is even more in play. It calculates there was another $7.3 trillion parked in IRAs and DC plans not invested in annuities, with an additional $2.2 trillion held in non-qualified mutual funds that were earmarked as retirement income.
What does that mean for annuity insurers? It underscores an enormous opportunity to move those dollars into their products, says Scott Hawkins, vice president of insurance research and consulting for Conning in Hartford, Conn.
As he sees it, annuity insurers have two chances to bite into that marketplace. The first is when people turn 65 and look to liquidate a portion of their accumulated funds to support their retirement. As the Conning reports points out, 2.7 million baby boomers reached age 65 in 2011.
There are the retirees who turn 70-and-a-half and must start taking required minimum distributions from their DC plans or IRAs. Last year, 2 million members of the so-called Silent Generation turned 71.
“Not only are insurers responding by marketing to this emerging group of retirees, but they are actively enhancing their existing products lines,” Hawkins says. “They are developing variable annuities that are aimed to capture that IRA rollover market.”
More than just devising new products, annuity insurers have a distinct advantage over mutual funds in their quest to grab a higher share of the retirement income market. “Only insurers can guarantee you get a steady income that you cannot outlive,” Hawkins says.
A recent report from Standard & Poor’s RatingsDirect entitled, “Annuities’ Share of the Retirement Market May Be Set to Grow” pretty much seconds Conning’s assertions.
One of the report’s authors, Li Cheng, a New York City-based director in North American Insurance Ratings for S&P, says this untapped market for individual annuity sales is potentially quite enormous. In comparison to the U.S. life insurance market, which she terms “saturated,” annuities have yet to make a noticeable dent in the retirement income arena. Citing statistics from the Investment Company Institute, the S&P report highlighted that as of the first quarter, only 9 percent of total U.S. retirement assets were held in individual annuities.
“Only insurers can guarantee you get a steady income that you cannot outlive.” ~ Scott Hawkins, Conning Research
The selling process
Tempting as those numbers may appear as a potential sales opportunity, selling annuities can be a daunting tasks for many reasons. Perhaps first and foremost is the price.
As Cheng reminds, “Insurance products are sold, not bought. When you are trying to sell something, price definitely comes into play.”
As if the price weren’t enough of a hurdle for advisors to overcome, annuities are not a well-understood product by the general public. Whereas they may understand other retirement income vehicles like mutual funds and CDs, annuities, particularly variable annuities, with all their moving parts and possible penalties, are more difficult for the average consumer to comprehend.
Further, in the past few years, carriers have responded to less than ideal market conditions by reducing the richness of the benefits and hiking prices, Cheng notes. “Typically, you’ll see variable annuity products with annualized charges of at least 300 to 400 basis points. This is very difficult for people to understand. Why do I have to pay such a high price for this product?”
Perhaps they don’t have to. According to Cheng, insurers are finding that in many instances, variable annuity policyholders may not be utilizing the guaranteed withdrawal benefits at all, or not using them to their optimal benefit. Since such riders can be quite costly, advisors should understand exactly what the client’s requirements are before selling a policy.
“The consumer is paying a very high fee to be able to utilize that guaranteed 5 percent or 6 percent withdrawal feature to cover their retirement income,” Cheng said. “But we have heard that many issuers are seeing the utilization of that withdrawal feature is not rational, meaning many are not using it to maintain that monthly income. In that case, if what they really care about is preservation of the principal, they don’t have to pay that high price to buy the withdrawal feature. They can buy a deferred annuity where you get principal preservation without paying the very high rider fee. So for advisors, it’s trying to figure out what exactly the retirement needs of the consumer are and what product provides a cost-efficient vehicle to satisfy that need.”
Insurers are aiming to make annuities more clear-cut as well, Cheng says. “Very likely going forward, variable annuities are going to go through another round of simplification to make them more user-friendly and easier to understand.” she says.
“Insurance products are sold, not bought. When you are trying to sell something, price definitely comes into play.” ~ Li Cheng, Standard & Poor’s
Another objection to annuities is the perceived lack of access to the policyholder’s money once it is handed over the insurance company. Yet both Cheng and Hawkins say the annuity industry has countered those objections with products that allow the policyholder to access their nest egg in certain circumstances, such as a long-term care event.
“There are some new products on the market that provide a long-term care feature in the variable annuity chassis,” Cheng says. “Whenever the policyholder has a need for long-term care, they can potentially accelerate the process of taking the money out.”
Solving the longevity equation
In addition to shoring up their capital structures after the economic collapse of 2008 and instituting new risk management techniques, annuity providers have taken a page from the property and casualty insurance playbook and are increasingly using a more predictive model to evaluate an individual’s probable lifespan. Instead of looking at an actuarial template, they are looking at person’s health history, lifestyle and socio-economic background, explains Conning’s Hawkins.
“If I have a better sense of your health, I can better adjust my payment to you and perhaps the premium I have to charge, based upon your life expectancy rather than just using a standard table,” Hawkins relates.
Not all at once
Even in light of the capital and regulatory pressures annuity insurers face, Hawkins contends the industry can process that $9.5 trillion, if for no other reason than that those assets are not going to transfer into retirement solutions all at once.
“We are looking at a market that is just starting to emerge and will last for decades,” Hawkins says. “That gives insurers a chance, if they have properly priced their products and managed their risks, to absorb this opportunity gradually, which lessens the demands on their capital. We also think this opportunity may attract new entrants or some that left may move back in again. So over time, the insurers will be well positioned to get their share of this retirement income market and it should be a big payout not only for the retirees who will get the income, but eventually a profitable business for the insurers.”