Demand for variable annuities remains strong: U.S. Study

Selling variable annuities — guaranteed minimum withdrawal products in Canada — may not be the easy sell it was, but it’s still a strong product offering. The challenge is whether product providers can continue to afford to offer them without rolling back more features and raising fees, a comprehensive study by the Financial Research Corporation concludes.

The Boston-based FRC, interviewed the 20 largest VA manufacturers in the U.S, which administer more than $237 billion in assets, and more than 250 advisors, in order to understand a profound shift in the VA business in the U.S. market. Product manufacturers have been left scrambling to cover off the guaranteed payments they owe investors — to the point where some companies have suspended offering variable annuities altogether.

The FRC study finds 83% of manufacturers are changing both allocation models and living benefits to reduce risk. Half are raising product fees, while half are discontinuing products.

“We saw a lot of companies start to discontinue benefits” says Scott Demonte, the director of Variable Annuity Markets for the FRC. “You look at The Hartford for example, they pretty much got rid of their entire wholesaling staff in the wake of the downturn. We wanted to take a look at how manufacturers could actually benefit, if at all, from this market upheaval.”

Demonte says the good news for VA providers is that clients still have a need for guaranteed sources of income. While advisors remain leery of higher fees and a roll-back of features, they generally remain committed to selling the product.

For example, 91% of advisors surveyed said they still consider using a VA as a rollover option for their clients, proof, the FRC says, that the products have solidified their place as a standby for retirement income. Sixty-five per cent say they the guarantee in itself is the primary reason for recommending the product.

According to the advisor data, the majority reported that current VA products are doing a good (53%) or excellent (29%) job during these troubling times. With demand for guaranteed income expected to grow, use of the product should remain steady, assuming it remains an option.

The FRC expects to see a rise in immediate annuity sales throughout 2009, but only among insurers that carry a credit rating of AA or higher, noting “these products are one of the easiest avenues to generate the income most investors need without requiring much work from the advisor.”

“The only reason we saw the sales go down is that when you have a declining market, even if you have those guarantees, people still don’t want to invest when they feel the market is going to go lower. That’s the main reason we saw the saw the sales drop off. The net flows look really strong in July and that’s due to the continued rally,” Demonte says.

“The actual demand for guarantees is not going down. In fact, I think they are going to increase, which could be a double-edged sword for insurers, because if they increase their [market share] beyond their expectations, they take on additional liabilities on their balance sheet and create more risk.”

Maintaining an AA rating remains a challenge in this volatile marketplace.

“The immediate threat to the [VA industry] is a continuation of the downturn, we have had a pretty substantial rally since the March lows, which has really helped the industry because it has started to bring cash values up to where they were about a year ago now. If we have another downturn or another leg down, I think there is a possibility of further changes happening in the product line,” Demonte says. “Product providers have already started to reduce guarantees. The next question is would they suspend them again or would they get rid of them altogether.”

He adds, “The irony is risk is reduced in offering the products when the market is lower — that’s a tough argument to make when you already have substantial losses on your books.”

Fees can only be raised so far to offset insurer balance sheet risk, the study notes. One of the reasons why VAs have not attracted the asset levels of mutual funds is largely due to their higher fees, coupled with the complicated structure of the product.

The study says a potential spike in VA fees and the reduced living benefit rewards will lead to more negative media coverage and tarnish the product in the eyes of investors.

Demonte expects the industry to hold fees in check by using more indexing products, such as exchange traded funds, in the underlying investment portfolios of the products.

There are two benefits to indexing: it’s cheaper for the client; and index funds are easier for the insurer to hedge.

“The biggest problem the insurance companies have right now is hedging against declining markets. That doesn’t sound too hard — you could just buy some put or call options — but when you’re talking about a growth or income portfolio, something that’s not 100% indexed, it actually very difficult to hedge,” he says. “We’re seeing a small move, but I think it will pick up, where insurers are including indexes in the portfolios. If you use an index portfolio, you know within 20 or 30 basis points that you can hedge yourself pretty accurately.”

Demonte notes that overall, Canadian insurers have been much more prudent in offering GWMB products, and while covering guarantees has placed them under stress, it’s not to the extent that American companies face.

“From what I know, Canadian insurers ran a much more conservative balance sheet compared to the American insurers,” Demonte says.

(09/04/09)