The deferred annuity world has changed dramatically over the past few decades. There was once a time where an annuity illustration seemed superfluous, especially back in the day when the deferred annuity was akin to a savings account and had few, if any, moving parts. What was once a simple and straightforward product has evolved into a series of products that may often be as complex as some of the more intricate life insurance products.
Over the years, selling deferred annuities has become more difficult. By illustrating annuities, carriers can demystify the complexities of these products and make them easier for producers to differentiate, compare and sell.
How did it all get so complex?
Variable deferred annuities were quite straightforward when they started to make a splash in the financial markets back in the latter part of the 1980s. While the variable annuity sold well, there was still some apprehension on how to mitigate the risk of potential and substantial losses to the annuity amongst those interested in purchasing a variable deferred annuity. It was this desire to mitigate the downside risk of variable annuities that opened the floodgates into many of the product features that deferred annuities have today.
- The guaranteed minimum death benefit. The guaranteed minimum death benefit (GMDB) was perhaps the initial product feature to address downside risk. The GMDB basically stated that the death benefit would not be significantly affected by market downturns as long as certain parameters were followed. Early GMDBs returned the full premium back to the beneficiaries. Then, compound increasing GMDBs came into vogue where the death benefit grew at a certain percentage each year (also known as a rollup death benefit). This was followed by the ratchet GMDB, where the death benefit was set to the highest fund value at certain durations.
- Living benefit riders. As the variable deferred annuity market began to grow in the bull market of the 1990s, “living” benefit riders began to be offered in various shapes and sizes. It was a literal alphabet soup of benefits with acronyms like GMAB (guaranteed minimum accumulation benefit), GLIB (guaranteed living income benefits), GMWB (guaranteed minimum withdrawal benefit), etc. There was even another death benefit rider that enhanced earnings to help the beneficiaries handle any decedent annuity tax liability.
Indexed deferred annuities came on the scene in the mid-1990s and became prominent in the early 2000s when the stock market corrected, leading to substantial losses in variable deferred annuity contracts. While the indexed annuity provides a guarantee and mitigates downside risk, it too has many moving parts and introduced nomenclature such as caps, participation rates and floors.
What impact do these features have on carriers and producers?
Of course, with all of these additional benefits arose new challenges for the distribution/sales force to be able to fully understand and properly sell such products. Administration became daunting as well. As the living benefit riders evolved, purchasers were given multiple choices as to which combination of riders could be selected, as well as the fact that any given rider could have multiple offerings.
All of this flexibility of choice made the potential numbers of rider combinations fairly significant, especially for home office personnel who had to make sure that the administrative system was fully able to handle all the potential combinations. This also created the need to develop a different stream of daily unit price vectors for just about each and every one of those combinations.
A regulatory solution?
In addition, suitability and other compliance requirements began to expand across the various deferred annuity product offerings, adding more challenges to the field force and the home office.
As a result, some companies selling deferred annuities have scaled back on certain product features. Some companies found that the administrative costs were prohibitive; others considered some of the living benefit riders to have potentially large loss tails. Still others found that the low interest rate environment was compressing earnings and in some cases leading to losses. Other companies have exited certain parts of the annuity market.
While some items have been scaled back, there are increasing complexities in other areas, such as compliance. One example is the Annuity Disclosure Model Regulation.
The NAIC introduced the Annuity Disclosure Model Regulation in mid-2011. While the annuity disclosure model regulation still has a way to go before it is passed by enough states to become a fully enacted regulation, it is expected to pass sometime in the next couple of years. In a nutshell, the annuity disclosure model regulation is a lot like the life insurance illustration model regulation introduced in the mid-1990s. The intent then (and now) was to standardize the illustration and put enough disclosures and plain language in the illustration output text to help the potential buyer make a better informed buying decision. There are several parts of the model regulation that companies have added to their illustrations over time, not due to regulatory pressure per se, but more due to the desire to make their product illustration more readily understandable to their clients and field force.
While the emphasis is on protecting the buyer as well as providing them with relevant information, such as how the annuity might perform under certain scenarios, the end result is that the complexity has grown yet again. The potential buyer has more information to digest; the agent has more to learn with respect to the new disclosures required by the model regulation; and the insurance company has more to implement with respect to its administrative and illustration systems.
What’s in store for deferred annuities and where do we go from here?
Just like life products, annuity products will continue to evolve to meet the needs of the financial markets. To simplify comprehension of complex annuity products, meet administrative challenges as well as regulatory requirements, the approach to illustration is imperative. It must be done in a way that is meaningful for distributers selling deferred annuities, simplifies information for review, and consolidates the administrative proposals so that products can be offered based on what is best for the client.