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5 steps to boosting revenue with deferred income annuities (DIAs)

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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.

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.

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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.

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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.

Lastly, insurers must be prepared to communicate a win-win value proposition to agents regarding DIAs. In fact, insurers that position DIAs as a product best discussed with an advisor (either in person or via the phone) may help create alignment among this important constituency.

The bottom line is that DIA sales are growing rapidly and, with more diversity in products and carriers, the future prospects look bright. Alignment between carriers and advisors and a shared focus on retirement planning will help secure the confidence of this growing market segment resulting in growth for the overall industry.

See also: Investment lessons from August’s market mayhem


3. Emphasize flexible premium products to attract younger consumers — and more overall.

Currently, many DIAs are sold as single-premium products that require large upfront payments. Most American consumers do not like to invest in illiquid assets, especially when such large one-time payments are involved. The biggest barrier in the minds of consumers is the fear that the initial payment will be lost if the policyholder dies soon after purchasing a DIA.

In addition, consumers are concerned about unexpected expenses in the future and illiquidity of DIAs.

It is important to note that some companies have attempted to address this issue by designing products with flexible premium options and/or death benefits that return at least the principal to the heirs of policyholders. The death-benefit options have gained popularity; however, they limit the amount of income paid to annuitants.

Though flexible premium products have yet to gain widespread traction, they seem posted for broader adoption in the future.

The key for insurers is to educate consumers (with enhanced online self-service capabilities) about the benefits of smaller, flexible premium payments, especially relative to the concept of dollar-cost averaging, and explain how putting in money over time provides exposure to various interest-rate environments.

Creative marketing and communications (e.g., using statements to present future income in terms of present value) may also help customers appreciate the value of DIAs.

See also: Deferred income annuities’ flex pay appeals to younger investors

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4. Target defined contribution plans as a source of business.

Insurers can seek additional DIA sales through institutions offering defined contribution and other retirement plans. Several factors make this an especially fertile market. For one, DIAs have been approved for use in target-date funds by the IRS and Treasury Department.

DIAs can also be an attractive option alongside other funds within retirement plans (especially those with many participants approaching retirement age), as well as being offered as part of target-date funds. Institutional marketing and sales programs should be directed to these opportunities.

5. Design products with competitive differentiation and risk appetite in mind.

When it comes to designing DIA products, there are many choices companies can make in terms of product features and target markets. These choices should be considered in terms of driving differentiation (an important consideration in an increasingly competitive market) and alignment with an insurer’s unique risk appetites.

This can certainly be a delicate balance to strike, but companies must get it right if they are to ramp up their DIA offerings and take full advantage of the growth opportunity ahead of them for the long term.

A win-win for insurers and society

DIAs represent a unique confluence of opportunities. There is real growth potential for the insurance industry and a societal imperative to a retirement safety net. Accordingly, it’s not a question of whether or if life insurers should enter the market, but rather when and how they should. In the near term, insurers must ask both strategic and operational questions, including:

  • What are the right products for customer targets given their current portfolios?

  • What infrastructure is necessary to scale up to meet this market demand?

  • How can DIAs help meet market demand for simpler products?

  • How can DIAs foster smart distribution strategies (such as increased engagement with advisors)?

These are the sorts of issues that the industry – including both insurers and advisors – must collectively address as they seek profitable growth by better serving the increasing number of middle-market consumers needing to generate more retirement income for longer periods of time.

See also:

5 fixed annuity questions you need to stop asking

For 401(k) plan participants, performance & balance are key

How to calm a panicked client? Look at stable assets

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.