Fixed Annuity Premium Study

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Third Quarter 2012 Fixed Annuity Sales

Economic Conditions: The economy improved in third quarter. GDP growth quickened sequentially. Unemployment declined. Equities prices rose while volatility decreased. However, the rate environment for fixed annuities actually worsened, thanks to the Fed and continued strong demand for bonds. Interest rates fell, the Treasury yield curve flattened, and credit spreads narrowed. To make matters worse, the Fed announced in mid-September that it would buy an additional $40 billion’s worth of mortgage-backed securities per month indefinitely and keep the fed funds rate near zero at least through mid-2015.

Company Developments

  • American General and Prudential exited the group long term care insurance business. Genworth trimmed its LTCI product line.
  • American Financial Group completed the sale of its Medicare supplement/critical illness business.
  • A major sale of AIG shares reduced government ownership to 16%. The company said it will rebrand operating units under the AIG name.
  • Athene Annuity agreed to buy Presidential Life.
  • FBL named a new CEO and CFO.
  • Genworth and shareholder Highland Capital held talks on the possible sale/spin-off of Genworth’s retirement/protection and mortgage insurance units. However, efforts to divest mortgage insurance operations were put on hold due to market conditions.
  • Guggenheim-owned EquiTrust and Security Benefit Life agreed to acquire the US fixed annuity business of Quebec-based Industrial Alliance.
  • Hartford inked deals to sell its I B-D (Woodbury) to AIG, its retirement plan business to MassMutual, and its life insurance unit to Prudential.
  • Jackson National/Prudential plc. completed the purchase of Swiss Re’s closed life insurance block.
  • MetLife said it will expand its group benefits business while curtailing VA sales.
  • Sagicor acquired PEMCO Life.
  • TIAA-CREF bought a majority stake in GreenWood Resources, a timber asset management firm.

Regulatory Developments

  • The most significant industry regulatory issues remained unresolved in third quarter. However:
  • The CFTC exempted all traditional insurance products from oversight of swaps usage.
  • An NAIC task force considered increasing reserve requirements for some residential mortgage-backed securities (later approved in October).
  • The NAIC approved model laws giving insurers flexibility in assessing their enterprise risk (Own Risk Solvency Assessment or ORSA), and permitting carriers to reserve for in-force universal life with secondary guarantees based on requirements in effect when the policies were issued. More stringent rules apply to newly issued policies.
  • The lead NAIC committee adopted a principles-based reserving manual for life insurance (later adopted by the full NAIC in early December).
  • California-domiciled insurance holding companies became required to disclose enterprise risks to the state insurance department.
  • Ohio became the latest state to adopt a 70/10 rule, limiting fixed/indexed annuity surrender charge periods to the greater of age 70 or 10 years.

The Rate Environment and Spreads: The rate environment for fixed annuities worsened in third quarter. Rates continued to decline. Third quarter’s average 10-year Treasury rate was a meager 1.78% — down 4 bps from the prior quarter.

The yield curve flattened due to the Fed’s purchases of longer term Treasuries and mortgage-backed securities, along with the impact of market expectations. Third quarter’s average 1-year/10-year Treasury yield curve flattened 18 bps sequentially. The flatter yield curve made fixed annuities (priced off the middle of the curve) relatively less attractive than other products like short-term bank CDs (priced off the short end of the curve).

Demand drove down spreads of investment-grade bonds over Treasuries.

Source: Bloomberg

Fixed annuity credited rates followed corporate bond and Treasury rates down, but a bit more slowly. The average 5-year CD-type credited rate of 1.45% was at its lowest level in the past 10 years.

Source:  Average Credited Rates from The Beacon Research Fixed Annuity Index: Average Benchmark Series™. Credited rates of these products do not change during the surrender charge period.

The slower decline in credited rates increased the 5-year/5-year fixed annuity rate advantage over Treasuries by an average of 6 bps quarter-to-quarter. However, sales did not rise in response. The decline in credited rates had more impact than the widened spread. Moreover, the fixed annuity rate advantage remained well off the highs of fourth quarter 2008.

Source:  Average Credited Rates from The Beacon Research Fixed Annuity Index: Average Benchmark Series™. Credited rates of these products do not change during the surrender charge period.

Fixed Annuity Sales by Product Type: Total estimated third quarter fixed annuity sales were $16.6 billion, almost 13% below the year-ago quarter and down 3% sequentially. Continuing the downward trend that began in Q2 2009, it was the weakest quarter since 2007. Persistency reportedly remained very high, which limited sales from 1035 exchanges. Year-to-date results fell to a 10-year low of $50.6 billion, down 13% from the first nine months of 2011 and off 40% from their most recent YTD peak in 2009. This was close to 2006/2007 levels, but down nearly 23% from the prior peak in 2004.

The negative overall results were due to dramatically lower sales of fixed rate annuities. As mentioned, carriers have steadily dropped the credited rates offered on these products in response to the low interest rate environment. This has seriously reduced demand, even though third quarter’s fixed annuity rate advantage was larger than at any time since May 2009.  Credited rates have clearly fallen below a minimum acceptable level for many consumers, especially because market rates could be expected to rise during surrender charge periods.

Both on a quarterly and year-to-date basis, fixed rate non-MVA and MVA sales were at Study-record lows. Income annuities had their strongest quarter ever, though payouts were reduced by lower long term rates. Indexed annuities had their third-best quarter, despite ongoing cuts in commissions, cap rates, premium bonuses, and GLWB rollup rates/payouts (as well as increased GLWB rider charges). YTD sales of both product types hit record highs. Income payouts looked attractive relative to low yields available elsewhere. This was especially true of deferred income annuities (DIAs), which generated 15% of third quarter’s income annuity sales and 77% of the sequential growth. Many cap rates were still competitive compared to credited and CD rates.  Premium bonuses and GLWB rollup rates offered by some products also attracted sales.

Improved results coupled with the fixed rate annuity decline gave indexed and income annuities record-high shares of quarterly and YTD fixed annuity sales. Indexed annuities claimed a 53% share in third quarter and 51% YTD, up from just 13% in the first nine months of 2003. Income annuities provided 14% of quarterly and 13.5% of YTD sales, more than doubling their 5% share in 2003. Gains came mainly at the expense of fixed rate non-MVAs. Non-MVAs still had the second-largest share of sales – 27% for the quarter and 29% YTD. But these were Study-record lows, down sharply from their YTD peak of 71% in 2003. Fixed rate MVAs had about 7% of quarterly and YTD sales. These were also record lows – less than half of their 15% peak in YTD 2009, but not far under their previous bottom of 7.5% in the first nine months of 2005.

Fixed Annuity Sales by Distribution Channel

In line with overall sales, results in all but three channels declined sequentially, period-to-period, and year-to-date. Downward pressure from declining rates was exacerbated for some carriers by the impact of recently consolidated wholesaling operations, where fixed annuities were receiving less attention than they previously did from specialized teams.

Independent producers continued as the leading channel with 55% of third quarter and 54% of YTD sales. These were Study-record highs, but this channel has claimed the strongest share in all but one period since third quarter 2004. Most independent producer sales have come from indexed annuities since 2004.  Their share of overall sales has steadily increased with the popularity of these products. Independent producers have dominated indexed annuity sales from the beginning. They generated 85% of third quarter and 86% of YTD indexed sales. However, this dominance is over-stated to an unknown extent. Marketing organizations are increasingly wholesaling indexed annuities to banks and broker-dealers. These sales are reported in the independent producer channel because they’re sold under marketing organizations’ master contracts. (Anecdotally, such wholesaling business is helping many marketing organizations stay afloat amidst cuts in commissions and the ever-shrinking number of independent agents.)

Banks were the dominant distribution channel until 2004, and have been second to independent producers ever since. Their share fell to Study-record lows of 19% in third quarter and 20% YTD. The bank share of total sales has trended down with the declining popularity of non-MVAs. However, banks remain the most important non-MVA channel, and non-MVAs still provide most of banks’ fixed annuity sales (44% in third quarter – a Study-record low). Bank sales of indexed annuities have grown steadily since 2010. However, this hasn’t been nearly enough to compensate for the decline in their sales of fixed rate annuities. In today’s low rate environment, Beacon continues to believe that banks could do more to reverse their market share decline by selling indexed annuities for retirement income rather than for their relatively competitive cap rates. Some say that this is beginning to happen.

Captive agents have been the third largest sellers of fixed annuities for the last decade. They generated 11% of both third quarter and YTD sales. They’ve also been the major channel for income annuities since 2009 (claiming shares of 31% for the quarter and 32% YTD).

Outlook

In the outlook section of our second quarter 2012 commentary, we predicted that things would get worse before they get better. That remains our prediction. Interest rates remain extremely low. Since June, credit spreads have narrowed and the Treasury yield curve become shallower. The Fed recently promised to keep rates low until unemployment falls below 6.5%, which could be significantly longer than the previously-announced minimum target date of mid-2015. So it doesn’t look like the rate environment is going to improve any time soon. Low rates are not only pushing down portfolio investment yields; they are also forcing issuers to increase reserves. To make matters worse, more will have to be reserved for residential and commercial mortgage-backed securities under new NAIC rules (oddly approved in fourth quarter despite the continued real estate recovery). Regulatory uncertainty continues to weigh on the industry as well. Of particular concern are the possibilities of a universal fiduciary standard and the elimination or limitation of tax deferral on annuity income. Many worry about the impact of private equity-owned players, too. Will they be good stewards of the annuity issuers they own, or take too many investment risks and damage the industry’s reputation? All of these factors point to a difficult 2013, when fixed annuity sales and profitability continue to decline.

On the other hand, we do not expect a dramatic drop in fixed annuity sales or more total exits like Hartford’s. Carriers want balanced sources of revenue and earnings, and fixed annuities will remain part of the business mix because market demand for guarantees is strong and growing. Carriers are developing new indexed and income annuity products, and investing in technology to reduce costs. We know of at least two new DIA market entrants. Some expect more carriers to enter the indexed annuity market as well.  While the industry must remain vigilant, we consider it unlikely that annuities will lose their tax-deferred status or that a fiduciary standard will force massive change on annuity distributors and producers. Many economists are even predicting that growth and employment will pick up relatively quickly once “fiscal cliff” issues are resolved, and that will improve the rate environment sooner rather than later. Things certainly will get worse before they get better. But get better they will.

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