The last several years have been very turbulent for the individual annuity industry, especially for traditional insurance providers and the advisor community. Coming out of the financial crisis of 2008, lingering low interest rates, non-traditional new market entrants (including private equity firms and start-ups) and changing regulatory requirements have proved extremely challenging. Significant shifts of the competitive landscape, with significant consolidation and several large players exiting the variable annuity (VA) market have further complicated matters.
The impacts of these shifts have been felt quite acutely by advisors, as reflected by their current skepticism toward insurance companies and wariness regarding their annuity offerings (most notably VAs). As the industry is aware, sales per advisor have drastically shrunk over the past 20 years. But, despite the setbacks, underlying demand for guaranteed income streams and higher yields remains strong, even as trust in insurers has been considerably weakened.
Indeed, the trust factor should not be underestimated. The frequent changes in pricing and funds, coupled with high-profile firms exiting the market, have seriously undermined the credibility of the insurers in the eyes of advisors. (Of course, consumers share these concerns, and for many of the same reasons.)
As a result, many analysts and observers have been asking what the industry – including large insurers, broker-dealers and distributors – can do to rebuild trust with advisors, seize current opportunities and establish a foundation for future success.
So where do we go from here? Are there better ways to deliver the guaranteed incomes that the market is demanding?
This article will highlight specific recommendations for insurers. Based on more than 100 hours of interviews EY conducted with insurers, distributors and others in the annuity industry, these recommended actions are designed in the spirit of our discussions to more clearly define the market, expand profit pools, create new bases of competition and generally improve the outlook for all annuity market participants.
1. Acknowledge the need to rebuild trust with advisors.
To a large extent, the industry is still suffering from the fallout of recent actions by large players. The constant variations and modifications of living benefits, prices and funds leave advisors wondering if they can strongly recommended products to their customers. It’s a dire situation, but EY research suggests that many in the industry have not yet acknowledged the gravity of these actions and their negative impacts.
There were intense financial pressures from low interest rates and depressed market conditions that forced insurers to make some drastic changes. All of the modifications were also “fair game” in the sense that they were featured in prospectus language. But these justifications have done little to placate a disgruntled and skeptical community of advisors. Only when insurers and suppliers fully come to terms with the consequences of their actions can they begin the process of rebuilding trust. The business case for rebuilding trust rests on the strong influence distribution channels have over the end customer. Their strong bargaining power must be recognized.
2. Continue to simplify and rationalize products.
In the past, many buyers of annuity products simply didn’t know what they bought just six months after making the purchase. In some cases, a single product might have had a dozen or more versions and permutations. Advisors unsurprisingly felt frustration from this as well. To put it bluntly: the more complicated products are, the harder they are for advisors to recommend and sell.
In the past several years, progress has been made. Some variable annuity products have become more rational, as companies are no longer acting aggressively to gain market share, but rather balancing their own needs and objectives with those of advisors and clients. However, manufacturers still have farther to go in developing simpler products. Irrational pricing still exists.
Take fixed-index annuities (FIAs) as an example. FIAs are very difficult to understand, and are often further complicated by the addition of new riders. Some have equated the “froth” in the FIA market – it’s estimated that they may overtake VA sales within a decade – to the early days of the VA market. All this suggests that the sins of the past may be repeated. It’s unclear if advisors truly understand these products. There are also concerns about long surrender charges and high commissions.
Again, the more indexes and crediting strategies are involved, the harder it is for distributors to understand and, ultimately, sell a product. Thus, there is a real competitive imperative for insurers to develop simple, stable products with long life cycles. Such products compare well to substitute offerings, such as mutual funds, and defend against new competitors from outside the insurance industry. That’s why advisors are clamoring for such products.
3. Focus on service and experience – and de-emphasize price.
Traditionally, players in the annuity market have competed on complex features and price. Moving forward, however, the emphasis will shift to performance, service and experience. This shift aligns to the stated preferences of advisors for simple products, with easy-to-understand features. Further, anything that insurers can do to support advisors in their service delivery to clients is likely to pay off over the long term.
In this sense, future competition in the annuity market will look more like the mutual fund and banking industries. Insurers that show that they are focused on good outcomes are likely to gain an advantageous position in the market.
4. Rethink innovation.
Given the cyclical nature of innovation in the annuity market, there is a growing sense that the next wave is on the horizon. This is a positive development as the last real innovation (the introduction of GMWBs) occurred in 2004. Such innovation is likely to be more customer oriented and market facing, and aligned to producing favorable outcomes.
This represents a significant shift from the past, when innovation programs were often undertaken with the goal of impressing analysts and stakeholders. In this sense, advisors can become important collaborators to positively influence product design and distribution models supported by rational, valuable guarantees and appropriate compensation. Again, regaining advisor confidence is likely to produce higher consumer confidence.
There is a seeming paradox here in that insurers feel a clear imperative to innovate, even as they must also reduce their risk exposure. New product development often leads to unexpected risks, especially when product lifecycles are long, as with annuities. To safeguard that future products are profitable and avoid some of the costly errors of the past, insurers must embrace more sophisticated modeling techniques and scenario analysis to confirm they understand how products will respond to different sets of economic conditions and market reactions. Early adopters have already defined a few leading practices relative to more fluid and flexible product structures, such as those with the ability to adjust bonus rates and withdrawal rates more quickly and efficiently than in the past.
The bottom line
Collectively, the activities and actions described above add up to growing the pie, or building both a bigger and better marketplace. Indeed, these recommendations and leading practices can provide an overall boost to the industry. That is, by making products simpler and more stable and by offering them to broader segments, it is likely the annuity market can return to growth mode.
Clear communication and a firm commitment to the business are essential variables of the equation for expanding the market. Insurers must clearly articulate their plans to be in the market for the long term, as well as the unique benefits of their offerings to advisors. To a large extent, this is a matter of insurers doing what they say they’re going to do – above and beyond the narrowest reading of contract terms. Listening more closely to inputs from advisors would also help rebuild trust and help boost the overall market outlook. Indeed, some stakeholders believe advisors have the power to change the industry for the better.
This is not to say that competition between individual players will cease, but rather that a healthier overall market benefits all participants. The growth of the entire market is a universally beneficial development, no matter the positioning of individual companies.
As much change as has occurred in the annuity marketplace in the last several years, more change is likely to come. To establish it is change for the better, annuity stakeholders must simplify their product offerings in the context of building stronger relationships with both consumers and advisors. There are clear reasons for optimism regarding underlying demand for guaranteed income streams. The choices insurers make in the near term regarding innovation, restoring trust and growing the overall market will go a long way to determining how effectively they can profitably serve that demand.
The views expressed herein are those of the authors and do not necessarily reflect the views of Ernst & Young LLP or the global EY organization.
Gerry Murtagh is an assistant director in the Insurance and Actuarial Advisory Services practice within Ernst & Young LLP in New York. She can be reached at firstname.lastname@example.org.
John Thelen is a senior in the Insurance and Actuarial Advisory Services practice within Ernst & Young LLP in Chicago. He can be reached at email@example.com.