Burning at Both Ends
As consumers used to a bull market seek investment gains over guaranteed income, historically low interest rates complicate efforts of providers to meet the challenge.
- Terrence Dopp
- January 2021
- Consumer Behavior: More than 10 years of growth in equities markets has consumers looking to annuities to capture more of the market upside than they would have sought in the past.
- Provider Behavior: Low interest rates have forced insurers to reprice income annuity products—making them less attractive to consumers—or curtail the instruments altogether.
- Filling the Breach: Registered index-linked annuities are becoming the preferred choice for both alpha-seeking consumers and companies looking to cut their interest-rate exposure.
Profit vs. safety. It's an age-old question in the financial services industry.
And now it's getting renewed attention from both consumers and the annuity industry as the country continues to endure the COVID-19 pandemic and faces the threat of additional economic fallout before vaccines can help mitigate the problem.
What can be an annuity's greatest selling points—safety, income and accumulation—can also be its greatest drawbacks after decades of falling interest rates that now hover at historic lows.
The annuity industry has long been viewed as a low-risk place to park money. With interest rates so low, insurers are in some instances shifting their product lineup—in part because of the investment climate, but also in response to consumer demand.
The markets that have gone up and up following the 2008 financial crisis have whetted consumer appetites for risk. But providers are finding themselves squeezed by the current low interest rates as they pay out guaranteed returns with a smaller amount of investment income. As a result, the market is often seeing a shift from older income-generating annuities such as immediate income and guaranteed offerings, to newer options such as registered index-linked annuities that move with markets and focus on accumulation.
In fact, registered index-linked annuities, also called RILAs, were the bright spot for the market in 2020, according to data compiled by the Secure Retirement Institute.
According to the most recent U.S. Individual Annuity Sales survey, estimated sales of all types of annuities were $55.3 billion in the third quarter, a jump of about 14% from the second quarter but still 7% lower than the prior year.
So-called income annuities slumped through 2020 as record-low interest rates cut into their income, the very value proposition they offer. The SRI projects these instruments will have fallen more than a third in 2020.
In the first three quarters of 2020, sales of fixed indexed annuities—which often contain riders providing income—were $41.4 billion, off 27% from the prior year. Total sales of $13.2 billion for the class in the third quarter were down by 29%.
Fixed immediate annuities, the bedrock of income annuity products, had their lowest quarterly sales in 16 years, with $1.4 billion sold in the period. That marked a 39% drop from the same period in 2019, according to SRI estimates.
There’s clearly some movement away from interest-sensitive products. … It’s a combination of market-driven—meaning movements that have made products less competitive in certain cases—and companies trying to de-risk or avoid interest rate exposure.
By contrast, the SRI report found sales of RILAs, which contain features common to both fixed index and variable annuities, were up 31% to $6.3 billion. RILAs offer more upside potential than their fixed cousins, with the caveat that policyholders must be willing to absorb some set risk of loss.
“For us, RILAs are the majority of our sales right now,” said Dave Hanzlik, vice president of annuity and retirement solutions at CUNA Mutual Group. “People are looking for safety and security, but they do want upside potential. It's a low interest rate environment, but they still need to grow their retirement savings.”
The impact of COVID-19 goes beyond canceled school and entertainment events. It's trickled into every corner of people's lives and bank statements. It's remote work for those lucky enough to have a job that wasn't furloughed, and preparation for stock market volatility.
In fact, every U.S. state but four—Michigan, Arizona, Florida and Arkansas—saw greater drops in gross domestic product during the first half of 2020 than they did in the Great Recession over a decade earlier, a University of New Hampshire report found. Even for those outliers, it wasn't so much they made any great shakes or wise decisions this time around, but that they had fallen so far and so fast the first time.
Battered by years of low interest rates that have crimped profits, providers in the recent past have moved to close some products, raise fees, introduce new variable annuity products and even shed some blocks as the industry evolves. Along with fixed annuities, the trend has applied to the guaranteed income riders that are often attached to variable annuities. Buying products with them has become more expensive, so demand has shifted.
“In this market those are very expensive to hedge, and it becomes even more so in times of volatility and low interest rates,” said Scott Hawkins, director of insurance research at global investment management firm Conning. “That's why you've seen companies get out of variable annuities. Over time, those benefits that are available cost more to the consumer, and they're not as robust or rich as they were say, 10 or 15 years ago.”
Take Prudential Financial Inc.'s newest offering: the FlexGuard variable annuity product. Like the aforementioned RILAs, FlexGuard's buffer is designed to help protect against losses.
The company said in November it saw $1 billion in FlexGuard sales in its first six months to make it the fastest-selling product of its kind; it accounted for 38% of all annuity sales in the third quarter.
In November, Prudential Chief Executive Officer Charles Lowrey said the company was on a path to de-risking and was pivoting in both its annuity and life insurance businesses. He said his company was discontinuing the sale of traditional variable products with guaranteed living benefits and may consider shedding or reinsuring some of its life and annuity business as it shifts from income guarantees to products that are less sensitive to low interest rates.
These competing desires for both the potential benefits of market growth and a buffer against investment loss have translated into a consumer behavior shift that has driven increasing movement toward products such as FlexGuard, Dylan Tyson, president of Prudential Annuities, said in an email.
“We continue to see customer demand shift away from traditional variable annuities with guaranteed living benefits to products that offer a degree of downside protection along with clear growth potential, provided to them with no explicit fees on the indexed crediting strategies,” Tyson said. “This consumer demand aligns with the approach annuity issuers are taking today in pivoting toward a portfolio that is more resilient to a low interest rate environment.”
Thomas Rosendale, a senior director with AM Best, said, at the same time some in the industry have announced moves to curtail annuity products most impacted by rock-bottom interest rates, other companies have been forced to reprice annuity products to the extent that securing income isn't cost-effective for consumers, so they've forgone the products.
RILA structures can vary, meaning customers at times can be offered the option to absorb the first percentage of any prospective losses—or have their providers exposed for the first losses up to a set threshold, leaving them on the hook for anything beyond the determined amount. What generally don't come are guaranteed income riders, which have grown less attractive amid the repricings, he said.
“There's clearly some movement away from interest-sensitive products both by design and out of necessity,” Rosendale said. “It's not just customer-driven. It's a combination of market-driven—meaning movements that have made products less competitive in certain cases—and companies trying to de-risk or avoid interest rate exposure.”
In this environment, potential clients are looking at interest rates, and they want a more attractive return. So they’re willing to trade some risk for investment return.
In the two decades from 2000 to 2019, 175 life insurers became impaired, according to AM Best data. Of those, 11 were engaged primarily in selling annuities. Three of those involved investment losses.
That move toward de-risking was on display in the October announcement that Venerable Holdings Inc. entered a deal with Equitable Holdings Inc. that will see it reinsure $12 billion in legacy annuity business and acquire Equitable's Corporate Solutions Life Reinsurance Co. unit, doubling its managed assets, Venerable said in a statement.
The reinsured variable annuity business, sold by Equitable between 2006 and 2008, is mature, stable and predictable, Venerable said. Venerable's general account assets will more than double from $11 billion to $24 billion, and reinsured business will increase to more than $46 billion in separate account value.
The transferred block will represent about a third of Equitable's fixed-rate guaranteed minimum business, or 13% of the total variable annuity policies in force as of June 30, AM Best said in an Oct. 28 commentary on the transaction. It's expected to create an estimated $1.2 billion of value on a statutory accounting basis, through an $800 million capital release, approximately $300 million of consideration paid by Venerable, and a $100 million tax benefit.
Also in October, American Equity Investment Life Holding Co. and two other companies said they will form a strategic partnership to establish a Bermuda company to reinsure $5 billion of American Equity fixed index annuity liabilities. Under the terms of the agreement in principle between American Equity, Värde Partners and Agam Capital Management LLC, Värde will establish the reinsurer.
Hawkins, of Conning, said not every firm is capable of marketing its own RILA products for technical reasons, but those that do will grow their presence in the market. The question is exactly how much share they hold and how much they want to have within the RILA space.
“On the one hand they're protecting themselves by saying 'Look, we'll absorb 5%, 10% of the loss, and beyond that you're on the hook Mr. Policyholder, but in return you get a bigger piece of the upside,'” Hawkins said. “In this environment, potential clients are looking at interest rates and they want a more attractive return. So they're willing to trade some risk for investment return.”
He sees the Equitable deal with Venerable as an important benchmark to watch for changes within the industry. He said the current climate is giving rise to “liability consolidators.”
“One of the things we're looking at is this sort of changing of the underlying business model—at least in the annuities space—to be the insurer as the manufacturer and distributor of the product, and then finding other partners to manage and handle the investment risk,” Hawkins said.
Don't count annuities out just yet, CUNA Mutual Group's Hanzlik said.
“We've been in a bull market. That makes the value of guarantees a little more difficult to conceptualize,” Hanzlik said. “Bull markets can lead to more of a focus on solutions that have more upside potential and [are] less focused on protection. We're definitely anticipating more and more growth.”