Within the annuity industry, increased longevity, the imminent retirement of the baby boomers, continued low interest rates, volatility in financial markets and, of course, the proposed DOL fiduciary rule remain the top concerns. Market and demographic trends underscore the stark reality that more people need to generate more guaranteed income across longer-term retirement horizons. This 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. But what does this mean for the annuity market? Will it continue to roll along in a business-as-usual mindset or is there a bigger and so far untapped opportunity?
There is a clear and expanding need for products that deliver guaranteed income, and new market segments to engage as an aging population faces retirement. In the summer of 2015, Ernst & Young conducted a series of interviews with senior executives from 20 U.S. life insurance and annuity manufacturers, distributors and reinsurers as part of an ongoing effort to understand how our industry can surmount current challenges and move forward. Here’s what’s on their minds with respect to annuities.
1. The types of annuities sold are changing, as evidenced by recent sales trends.
Slightly higher interest rates and continued consumer demand for lifetime income are generally positive indicators for annuity sales. Thus, it is likely that sales of annuities will remain strong; however, the mix of sales will continue to shift and the market leaders will change, too. The leading driver of annuity sales growth is fixed index annuities (FIAs), which have seen steady sales increases from 2012 to 2014. Growth of FIAs continues to be strong among all distribution channels, and broker-dealers continue to increase their footprint in this space.
In the post-recession period, several annuity carriers intentionally reined in variable annuity (VA) sales, while companies are entering the FIA market and adding lifetime income riders to existing fixed-index annuities. FIAs continue to appeal to consumers because of their principal protection and generous bonuses and withdrawal rates on their guaranteed lifetime withdrawal benefits (GLWBs). Some GLWBs on FIAs offer bonuses of 8 percent and withdrawal percentages higher than the withdrawal percentages available on GLWBs on VAs. Variable annuities have not experienced any real growth over the past few years since many insurers have stopped selling living benefits on Vas, or have increased the cost of the benefits. The recent spikes in volatility also didn’t help VA sales, since consumers fled to more conservative investments.
According to the LIMRA Secure Retirement Institute, total annuity sales in 2014 grew 3 percent and reached US$236.9 billion, driven by strong fixed annuity growth. Sales of index annuities reached record levels in 2014, up 23 percent from the prior year, while sales of variable annuity sales declined 4 percent to the lowest annual level of sales since 2009. These gains for FIAs have helped compensate for declines in variable annuity sales, which have slowed despite strong equity markets. For the first half of 2015, net sales for FIAs were US$14.1 billion, yet net sales were negative US$11.7 billion for VAs.
Deferred Income Annuity (DIA) products were introduced a few years ago, and premiums have grown from US$200 million in 2011 to approximately US$2.7 billion in 2014. These are dramatic gains, and while the share of DIAs remains relatively small compared to the remainder of the annuity market, we believe that they will continue to gain market share.
These recent sales trends suggest that annuity providers will attempt to keep up with shifting market needs even as the low-interest rate environment lingers. As one survey respondent stated, “our challenge is to create and sell affordable products so that we don’t have high lapse rates.”
2. We’ll see more evolution in product design.
More evolution and innovation in annuities are likely to result from these market shifts. It is clear that variable annuities may not look like they did six or seven years ago, and FIAs will change significantly, too. As one respondent stated, “we add product features not because we think of them, but because people want them. Then we go through a Darwinian process where the losers die and the winners thrive.”
FIAs are now increasingly seen as a source of guaranteed income for retirees. Baby boomers are still the primary buyers of FIAs, and carriers are creating new indexes and developing new FIAs that offer consumers greater choice and flexibility, both of which are important to boomers.
However, with the effects of the financial crisis still lingering, FIAs could increasingly appeal to younger generations since many are wary of stocks and are looking for more stable options. To seize this opportunity and meet the needs of this relatively new customer cohort (i.e., millennials), companies will have to continue to innovate and adapt to their needs.
Today, VA product innovation has slowed though the retooling of living benefits continues, with companies introducing rate sheet supplements to adjust the levers more quickly. Similarly, other companies are linking levers in their living benefits (LBs) to a formula involving the VIXX or U.S. 10-Year Treasury rate to allow them to react to changing market conditions much more quickly.
As one respondent said, “The ability to change quickly is key in this environment.”
Guaranteed living benefits (GLBs) still resonate with VA buyers, but the lion’s share of today’s optional income and withdrawal guarantees come with higher fees, tighter investment restrictions and greater complexity, as compared to GLB riders of years past.
New investment-only VAs, or IOVAs, are being sold strictly for tax-deferred accumulation, giving contract owners a larger range of investment options in which to invest premium payments. These are the variable annuities of the 1980s and early 1990s but with far more fund choices. Because of the vast number of subaccount options, IOVAs appeal to younger, pre-retirement investors as a way to diversify and accumulate savings.
Many DIA companies have introduced qualified longevity annuity contracts, or QLACs. Last year, the U.S. Treasury adopted the QLAC rule to improve accessibility and usability of DIAs in qualified retirement plans, including individual retirement accounts. Today, nine companies are offering QLACs, according to LIMRA.
Looking at product design, companies have many choices to match product features and target markets. These choices can drive differentiation (a critical concern in an increasingly competitive market) and stay within an insurer’s risk appetite. If companies are to take full advantage of the growth opportunity relative to the annuity market place, this is the balance they must strike.
3. The industry must catch up with technology leaders.
Technology-based innovation has never been a particular strength for annuity providers. In fact, the industry has long been considered a laggard. But, looking ahead, rising consumer expectations are forcing faster adoption of advanced technology. More executives recognize the broad appeal of mobile channels, especially for self-service and common administrative tasks. For example, today’s consumers expect to be able to access their annuity account values via their smartphones (much as they can with stock portfolios).
Similarly, the development of straight-through processing for transfer business (for example, on IRA rollovers and 1035 exchanges) offers considerable value for both consumers (a more efficient process and streamlined experience) and insurers (reduced costs).
Insurers must be prepared to make investments in better technology, with a value proposition aligned to increased customer engagement. The high-quality experiences consumers have with digital leaders like Google and Amazon have raised the bar for everyone, including annuity companies. As one respondent stated, “In today’s world, everything has to be mobile-first. Not desktop, not email, but mobile first.”
See also: What if Google or Amazon sold insurance?
Distribution channels are another area where significant and rapid technology evolution is to be expected. New and different distribution channels (including direct digital and mobile channels) and the rise of new business models and competitors (such as “robo advisors”) are among the technology-based forces reshaping the market. Robo advisors in particular are placing more pressure on annuity providers. As another executive stated, “buying habits are changing, and we’re going to have to change with them.”
4. Self-policing and a more thoughtful approach to client service are imminent.
There are many regulatory initiatives underway that are aimed at better educating and protecting annuity customers against financial abuse. Over the last few years, many insurers have enacted methods to collect customer information, establish proper record-keeping practices and require product education and training. By all accounts, they are focused on the long-term best interest of their clients. Some companies are going one step further by adjusting their offerings and morphing their business models. For instance, one broker-dealer has stopped selling a particular VA share class with riders and has begun requiring clients who want to purchase this share class without riders to sign a third-party cost analysis report that compares the cost of different share classes offered by the same firm.
Adopting these changes will not be easy, but there is potential value in strengthening customer relationships by becoming advocates for their financial security. There is a clear need, across market segments and at every level of society, for more financial guidance and products that increase financial peace of mind. Some forward-looking leaders see an opportunity for the industry to “do well by doing good” in meeting the needs of families and individuals. Annuity providers will need to work closely with their advisors and agents to find a way to profitably seize the opportunity while still meeting regulatory requirements.
5. More disruption is in the cards for distribution.
Similarly, the proposed DOL rule could cause radical changes in the way companies handle distribution. Though the final rules are still in the works, the impact of the proposed U.S. Department of Labor (DOL) fiduciary rules could be profound. There are important implications across the business, from the service and advisory models to product disclosure to CRM. On the product side, the proposed fiduciary rule will increase compliance costs. Advisor compensation models will move away from commissions and increasingly be based on fee-based models.
The scope and severity of the proposed changes led one industry CEO to conclude that the proposed DOL fiduciary rule could force companies to choose between manufacturing or selling products, since they may not be able to do both. The fact is that the proposed DOL fiduciary rule could fundamentally change the way annuity business is written and how advisors are compensated.
The bottom line: the industry must continue to innovate to meet the needs of customers.
Profound forces of change continue to reshape the annuity landscape, with significant impacts on multiple dimensions of the business, from product design and sales to technology and regulatory compliance. That is why innovation is increasingly viewed as an imperative, as demonstrated by the results from EY’s survey of industry executives. Annuity providers simply must embrace innovation if they are to meet the needs of today’s customers, navigate the significant challenges in front of them (including the proposed DOL ruling) and seize the considerable opportunities presented by ongoing market evolution.
The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young LLP or the global EY organization.