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.