Increased longevity. The imminent retirement of the baby boomer generation. The rise of defined contribution plans and fall of defined benefit and traditional pension plans. Low yields on traditional income-producing options, such as bonds. Potential volatility in financial markets. The prospect of changes in Social Security benefits.
The confluence of these forces is complicating retirement planning for millions of Americans. And it is presenting both challenges and opportunities for the individual annuity market. Certainly, market and demographic trends underscore the stark reality that more people need to generate more guaranteed income across longer-term retirement horizons. That includes the so-called middle-market segment of retirees who have relatively limited investable assets but still need to generate sustainable income for 20 years or more.
For the life insurance and annuity industry, this is very much a good news/bad news scenario. On the one hand, there is a clear and expanding need for products that deliver guaranteed income. There are also new market segments to engage as an aging population faces retirement. This is good news given the urgent need for top-line growth.
On the other hand, the maturity of the variable annuity market means many companies and advisors are seeking a new growth engine. While variable annuities may still be attractive to consumers seeking to generate retirement income, factors such as product complexity and excess features are contributing to a shift towards new and simpler products.
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Deferred income opportunities emerge as a potential growth engine
One product that offers such growth potential is the deferred income annuity (DIA). DIAs work similarly to immediate-income annuities (which have been around for decades), though payment begins at a later date.
Fundamentally, they allow individuals to transfer longevity and investment risk to insurers. Often regarded as a “pension alternative,” DIAs help to provide policyholders with peace of mind and guaranteed income through their retirement years.
Since DIA products were introduced a few years ago, premiums have grown from $200 million in 2011 to approximately $2.7 billion in 2014. Despite these dramatic gains, DIAs remain a relatively small slice of the annuity market.
Currently, mutual companies account for the largest share of the DIA market, though more companies are entering the market. This should result in increased competition for insurers and more choice for consumers.
To better understand the growth opportunity for those interested in this segment of the market, EY conducted a series of interviews with insurers, distributors and other stakeholders in the annuity industry. Our research highlighted five key considerations for insurers and advisors seeking to increase DIA sales.
1. Recognize the external factors that shape the market.
While the growth outlook for DIAs is positive overall, it is important to remember how external factors may affect the market. For example, take the changes to interest rates, which have been shown to affect the sales of DIAs.
The low interest rates that have been prevalent for so long are likely to rise in the future, as the Federal Reserve starts to increase them early next year. This will provide greater income for a dollar of premium, increasing their appeal to consumers who comparison shop.
Similarly, volatility in equity markets makes DIAs, with their stable and predictable income streams, look more attractive to individuals and advisors.
Regulatory developments also shape the market for DIAs. For instance, last year, the IRS formalized a new tax treatment for this form of longevity insurance.
Under this rule, individuals can place 25 percent of their retirement assets, up to $125,000, into a DIA, which is shielded from required minimum distribution requirements at age 70½. Individuals investing into DIAs must begin to receive distributions by age 85.
Other relevant regulatory actions include guidance provided by the U.S. Department of Treasury on the use of DIAs within target-date funds that are part of retirement plans. Changes in any or all of these guidelines may have profound market impacts.
Certainly, lifting the cap of $125,000 would do a great deal to further boost market demand. In the immediate term, insurers can lay the groundwork with thoughtful product design and distribution plans.
At the same time, advisors must be prepared to serve new customers in new ways. Collectively, these steps will help ensure all stakeholders capitalize on the increased demand when these external market forces align favorably.
2. Recognize the opportunity to go beyond DIAs and help consumers with broader retirement planning
DIAs may seem relatively simple to explain and sell. However, there are various ways for consumers to use them. Policyholders can fund premiums in their 40s or 50s and begin to receive income once they reach retirement age.
Another common way to use DIAs is to draw down other invested assets up to a certain age, and then begin payments from the DIA. This approach helps address longevity risk and provides higher income due to the longer deferral period.
Given the increased diversity in product features, carriers and uses, there is a real and important role for advisors to play in DIA sales, as consumers will need to understand where and how they fit in the context of broader retirement plans. Advisors are well-suited to help consumers understand the asset allocation implications surrounding DIAs and how they complement other types of investment vehicles.
In this sense, DIAs may offer forward-looking agents an opportunity to build new customer relationships and strengthen existing ones by looking at the broader retirement plan and perhaps attracting other assets. Insurers may need to help their agents understand the bigger-picture opportunity to expand client relationships.
Short of reworking commission structures, insurers can provide their agents with training, tools and educational materials that may make DIAs easier to sell — and better explain their benefits to consumers.