Taking a punch: insurers never anticipated a bear market so long and deep that it would ravage their variable-products businesses--and cause them to rethink how they conduct them. (Life/Health: Annuities).When economic times are bad and investment portfolios get hammered, most insurers can at least charge more for their products.
That option isn't available to writers of variable annuities Variable annuities
Investment contracts whose issuer pays a periodic amount linked to the investment performance of an underlying portfolio. , which generate revenues based on assets under management Assets Under Management (AUM) is a term used by financial services companies in the mutual fund and money management or investment management business to gauge how much money they are managing. . These companies suffer the extra burden of lower revenues from their product portfolios, lower sales and the detrimental effects of greater amounts at risk. Some industry leaders say the losses will drive the most significant changes in variable-annuity design in the past 15 or 20 years.
Only three years ago, variable annuities were a nearly $1 trillion industry as measured by total net assets Net assets
The difference between total assets on the one hand and current liabilities and noncapitalized long-term liabilities on the other hand.
See owners' equity. . By Sept. 30 of last year, that figure had fallen to about $750 million.
How have variable-annuity writers been hurt by this deepest of bear markets since 1929 to 1932? Let's count the ways:
* Sales have dropped. Three major gatherers of variable-annuity statistics--Limra International, the Variable Annuity Variable Annuity
An insurance contract in which, at the end of the accumulation stage, the insurance company guarantees a minimum payment. The remaining income payments can vary depending on the performance of the managed portfolio. Research and Data Service (VARDS) and Tillinghast Towers-Perrin--independently have reported premiums failing from a high of about $137 billion in 2000 to somewhere between $111 billion and $113 billion in 2001. They report sales of $83 billion to $88 billion through the first three quarters of last year.
* Fee income has fallen in line with assets under management. The fees linked to assets include mortality and expense charges, enhanced-benefit charges and fees paid to managers (often third parties) of a contract's subaccounts. Administrative fees usually are flat charges.
* Higher costs to cover greater exposure to death benefits and living benefits. Variable-annuity premium was greater in 1997 through 2000 than in all of the product's prior history Most of those sold in the four years of that recent bull market now have death benefits that are "in the money," the phrase the industry uses to describe its net amount at risk. That means the amount the investor paid in premiums less any withdrawals is greater than the current value of the contract. In some cases, however, the net amount at risk is greater because insurers provided death benefits equal to the highest anniversary value, a guaranteed growth rate compounded annually, or some other mechanism.
The exposure to these higher benefits is costly in a couple of ways. One is that under generally accepted accounting principles The standard accounting rules, regulations, and procedures used by companies in maintaining their financial records.
Generally accepted accounting principles (GAAP) provide companies and accountants with a consistent set of guidelines that cover both broad accounting , insurers are allowed to amortize amortize
To write off gradually and systematically a given amount of money within a specific number of time periods. For example, an accountant amortizes the cost of a long-term asset by deducting a portion of that cost against income in each period. over many years the expense of acquiring the business as long as the business meets profit projections. When profits fall short, insurers must account for these deferred acquisition costs sooner, thus impairing their reported earnings. Insurers using statutory accounting must have reserves protecting the benefits. Although there is no formula for calculating reserves uniformly across all 50 states, the National Association of Insurance Commissioners The National Association of Insurance Commissioners (NAIC) is an Internal Revenue Code Section 501(c)(3) non-profit organization which seeks to organize the regulatory and supervisory efforts of the various state insurance commissioners from around the United States. and the American Institute of Certified Public Accountants With over 330,525 CPA members (in August 2006), the American Institute of Certified Public Accountants (AICPA) is the largest professional organization of Certified Public Accountants (CPAs) in the United States of America. are working on one that would be required under both GAAP GAAP
See: Generally Accepted Accounting Principles
See generally accepted accounting principles (GAAP). and statutory accounting.
* Less availability of reinsurance The contract made between an insurance company and a third party to protect the insurance company from losses. The contract provides for the third party to pay for the loss sustained by the insurance company when the company makes a payment on the original contract. . Some insurers have reinsured the death-benefit risk, but industry experts report the availability of this reinsurance has fallen sharply.
* Greater use of insurers' fixed accounts within the variable-annuity contract. These fixed accounts have rates that insurers have guaranteed never to fall below a certain amount. Some are as high as 4%, and the higher utilization of these accounts represents another drain on insurers finances.
Financial Repercussions repercussions npl → répercussions fpl
repercussions npl → Auswirkungen pl
A.M. Best Co. downgraded the financial strength of six insurers during 2002 and January 2003 due to variable-annuity related issues: Allmerica Financial, American Skandia, Merrill Lynch Merrill Lynch & Co., Inc. (NYSE: MER TYO: 8675 ), through its subsidiaries and affiliates, provides capital markets services, investment banking and advisory services, wealth management, asset management, insurance, banking and related products and services on a global basis. Life, Cigna, Sage Life and Axa Corporate Solutions Life Re. Companies with negative outlooks due to variable-annuity issues are MONY MONY Mutual of New York (Insurance - Syracuse, NY) and Transamerica Canada. Overall, A.M. Best downgraded 53 life/health companies and upgraded 19 during the 13-month period.
The declines in fee-based income and the drop in sales are probably the most significant factors hurting the variable-annuity writers, said Eric Sondergeld, Limra International's corporate vice president and head of its retirement research center. "These companies have been accustomed to asset bases growing--and growing rapidly--and to using them to fuel new development," he said. Product development "slowed to a crawl" during the bear market, he added.
One part of the variable-annuity business that hasn't worsened during the bear market has been surrender rates. Sondergeld said surrenders have never been high and that they fell as the stock market swooned. He attributed the reduction to a lack of attractive investment alternatives and to the fact that many death benefits "came into the money."
Sondergeld found some irony in the death-benefit situation. "These benefits were kind of poked at by the press, and now these benefits have value," he said. "That's a good thing. So it's a kind of blessing in disguise. It demonstrates the risk associated with the markets, and here is a feature that currently has some value."
Nancy Kenneally, senior consultant with Tillinghast Towers-Perrin in New York New York, state, United States
New York, Middle Atlantic state of the United States. It is bordered by Vermont, Massachusetts, Connecticut, and the Atlantic Ocean (E), New Jersey and Pennsylvania (S), Lakes Erie and Ontario and the Canadian province of , identified exposure to guaranteed benefits as having the most detrimental effect on variable-annuity writers. She said some companies, particularly those that attracted buyers with high-performing funds during the bull market, face deep exposure and have increased reserves they need to hold at the end of the year. Making matters worse, reinsurance on these benefits "continues to be pretty much nonexistent non·ex·is·tence
1. The condition of not existing.
2. Something that does not exist.
non ," she said.
But Kenneally said that dwindling dwin·dle
v. dwin·dled, dwin·dling, dwin·dles
To become gradually less until little remains.
To cause to dwindle. See Synonyms at decrease. fee-based income also has been a big concern and that greater use of fixed accounts, which don't generate much in fees, has hurt writers, particularly if they are crediting an attractive rate. "Some companies have had to close their fixed accounts in certain products, particularly in C-share contracts, in which there is no surrender charge Surrender Charge
A fee levied on a life insurance policyholder upon cancellation of his or her life insurance policy. The fee is used to cover the costs of keeping the insurance policy on the insurance provider's books. ," she said. "Also, high rates in dollar-cost-averaging fixed accounts have been a drain on profitability, but we have seen those enhanced rates come down quite a bit."
Insurers set up special dollar-cost-averaging fixed accounts to attract contract buyers by offering exceptionally high rates. The buyers would then be required to invest periodically-- usually monthly--into other subaccounts in the contract over a specified period such as 12 months until the special account was depleted de·plete
tr.v. de·plet·ed, de·plet·ing, de·pletes
To decrease the fullness of; use up or empty out.
[Latin d . Kenneally said that such accounts designed to be depleted over six months averaged rates of 6.05% at the end of June and 5.7% at the end of September.
Many variable-annuity writers have been able to offset losses in that business by writing more fixed annuities Fixed annuities
Contracts in which an insurance company or issuing financial institution pays a fixed dollar amount of money per period. , in which they have been crediting at guaranteed rates in the range of 3.5% to 4%, Kenneally said. Insurers' earnings from fixed annuities come from rates on the money they invest that are higher than the rates they pay to contract owners.
On the positive side, any stock-market upturn this year would likely have an immediate positive effect on the variable-annuity industry. "It would rebound fairly quickly," she said. "Typically, we don't see a lag in sales. Sales follow the market." The rebound would be slower in variable life because it is more a protection product than an investment product and because the underwriting process extends the time required for a sale to hit the books, Kenneally added.
But simply treading water until the stock market rebounds might not be good enough for the variable-annuity industry. Rick Carey Richard ("Rick") John Carey (born March 13, 1963 in Mount Kisco, New York) was an American backstroke swimmer of the 1980s who won three gold medals at the 1984 Summer Olympics in Los Angeles. He broke nine world records, five individually, and also was a double world champion. , managing director of professional services (job) professional services - A department of a supplier providing consultancy and programming manpower for the supplier's products. at VARDS and editor of The VARDS Report, said the industry might have to retool re·tool
v. re·tooled, re·tool·ing, re·tools
1. To fit out (a factory, for example) with a new set of machinery and tools for making a different product.
2. and reprice its products to reduce the correlation between fee income and assets under management.
"This industry is at a crossroads the likes of which we haven't seen for 15 or 20 years," he said. "It will have to integrate and institutionalize in·sti·tu·tion·a·lize
To place a person in the care of an institution, especially one providing care for the disabled or mentally ill.
in the retooling of products to make profitability based on other metrics, not on account values."
During the bull market, recommendations by distributors drove product design, which was a case of "the tail wagging the dog," said Carey. Insurers felt a need to match the competition. "In the bull market, everybody was making so much money you could price these things "These Things" is an EP by She Wants Revenge, released in 2005 by Perfect Kiss, a subsidiary of Geffen Records. Music Video
The music video stars Shirley Manson, lead singer of the band Garbage. Track Listing
1. "These Things [Radio Edit]" - 3:17
2. in any shape or form," he said.
But the bear market brought clarity to the situation, "and consulting actuaries have been counseling companies that they really need to get a hold of their profitability and shareholder value," said Carey. Reining in the demands of distribution might be "part and parcel" of exercising financial responsibility, he added.
Carey said actuaries have told him this next generation of products is in the works. "These actuaries can't reveal their clients, but I understand these products are ready to be filed or already have been filed;' he said.
Part of the retooling might involve charging more for death benefits and living benefits. For example, guaranteed-minimum-income benefits are a "real bargain" for buyers today, according to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. Carey. "Many are priced at 25 to 35 basis points, which is not even at break-even;' he said. Guaranteed-minimum-income benefits, which come into play when contract owners are in the payout phase Payout Phase
The phase in an annuity during which payments are made to the annuitant. These are usually paid on a monthly basis and last for the lifetime of the annuitant. The income received from an annuity by a retired investor is considered taxable income. , are being "very well received;' said Frank O'Connor, senior industry analyst for VARDS. A typical GMIB GMIB Guaranteed Minimum Income Benefit (Insurance) guarantees an income floor even if the owner's variable accounts don't perform well. The newest kind of living benefit is the guaranteed minimum withdrawal benefit, according to Kenneally. It guarantees the contract owner can withdraw at least the net amount invested after the passage of a stipulated time--such as five years-- regardless of the performance of underlying investments. The owner might even be allowed to withdraw a nominal amount each year within the stipulated period. Kenneally said Hartford Life and ING have offere d annuities with the guaranteed minimum withdrawal benefit.
On the death-benefit side, new options include a 40% increase in the benefit to pay income taxes, said O'Connor. Unlike the death benefits of life insurance, those of annuities are taxable.
Regarding distribution, Carey said there is talk in the industry of more service-based compensation models along the lines of the managed-account business, in which the individual adviser rather than the product manufacturer earns a fee based on assets managed. But changes in compensation models might be easier said than done. The hard part for the industry is that some company usually is willing to take the risk of paying higher, transaction-based commissions to increase its distribution, Carey said.
Even if the industry is able to reduce its costs of distribution, its efforts to rebuild might be stymied by any regulatory requirement Regulatory requirements are part of the process of drug discovery and drug development. Regulatory requirements describe what is necessary for a new drug to be approved for marketing in any particular country. for higher reserves. Carey said some companies might have to reserve 10 or even 20 times as much as they do now "If such a requirement went into effect, a lot of companies would have to ask themselves whether it is profitable to be in this line of business," he said, adding that regulators don't expect any requirements to be so onerous that they could have a significant impact on the number of insurers offering variable annuities.
Carey said there is still much uncertainty facing the industry over the next three years. Measured in terms of net flows of money coming in, the industry is in worse shape than in terms of new sales. Net flows are new sales minus exchanges from existing annuities into new ones, and that gap has become very wide since 1996. In 2001, the industry recorded $106.6 billion in new sales, but only $30 billion of that amount was in net flow, according to data by VARDS. Through the first nine months of last year, new sales were $81.8 billion, but net flow was only $23.7 billion.
"If you're looking for Looking for
In the context of general equities, this describing a buy interest in which a dealer is asked to offer stock, often involving a capital commitment. Antithesis of in touch with. signs of a rebound in the industry, you'll want to see net flows improve," Carey said. "And then there's the bear market. Company executives don't know Don't know (DK, DKed)
"Don't know the trade." A Street expression used whenever one party lacks knowledge of a trade or receives conflicting instructions from the other party. where it's going. It's still an uncertainty. It could turn out to be four years and running, and that would force more people out of the business more consolidation."
Variable Annuity Sales by Product Type
(Jan. 1-Sept. 30, 2002)
* A-Share--Annuities with front-end loads Front-End Load
A commission or sales fee charged at the time of the initial purchase for an investment, usually mutual funds and insurance policies. It is deducted from the investment amount and thus, lowers the size of the investment.
* B-Share--Annuities with traditional back-end loads Back-End Load
A fee an investor pays when selling a mutual fund within a certain number of years, usually seven.
Sometimes in exchange for paying no fees up front, the investor pays an annual fee for marketing and managing that is higher than the fees charged for a (surrender charge period is typically 7-8 years or longer)
* C-Share--Annuities with no back-end loads (no surrender charges)
* L-Share--Annuities with short surrender charge period of 3 or 4 years
* Bonus--Annuities that credit a bonus (typically 3% to 5%) of premium to the policyholders' account value at contract issue. Presence of the bonus may come with a lengthened length·en
tr. & intr.v. length·ened, length·en·ing, length·ens
To make or become longer.
lengthen·er n. surrender period, higher product charges, a lower gross dealer concession Gross Dealer Concession or GDC is the revenue to a brokerage firm when commissioned securities and insurance salespeople sell a product, whether it is an investment like stocks, bonds, or mutual funds, or insurance like life insurance or long term care insurance. , reduced profit margins or some combination thereof.
* VIA--Variable immediate (payout) annuities.
Total % of % of Product # of Premium # of Average Qualified Total Type Products ($ millions) Contracts Size Premium Premium A-Share 2 $221 1,247 $74,087 52% 0% B-Share 147 30,020 437,572 51,033 58 49 C-Share 49 15,750 294,222 93,791 68 26 L-Share 28 3,892 43,854 77,484 56 6 Bonus 35 11,137 128,060 72,953 53 18 VIA 3 238 1,662 143,378 79 1 Total 264 $61,258 906,617 $61,507 60% 100% Source: Tillinghast Towers-Perrin Variable Annuity and Life User Exchange Net Investment Returns by Fund Type Like the stock indexes, equity funds inside variable annuities fell sharply in the year ending Sept. 30, 2002, based on a weighted average net return. Bond funds provided positive returns, except for high-yield funds. 1-Year Weighted 5-Year Weighted Number Average Average Fund Category of Funds Net Return Net Return Growth 2,186 -19.6% -3.3% Aggressive Growth 772 -18.6% -4.7% Growth & Income 854 -18.6% -2.6% International Stock 768 -17.0% -5.1% Government Bond 110 7.2% 5.9% Corporate Bond 311 4.5% 5.5% High-Yield Bond 206 -3.2% -4.3% International Bond 54 5.2% 1.3% Money Market 188 0.8% 3.6% Balanced 380 -10.6% 0.4% Specialty 343 -5.7% 3.2% Total 6,172 -13.5% -1.2% DJIA -12.5% 0.8% S&P 500 -20.5% -1.6% Source: Tillinghast Towers-Perrin Variable Annuity and Life User Exchange