Variations on a Theme.

Insurers are embellishing variable annuities with new packaging and benefits to make them more competitive.

After 12 consecutive years of growth, sales of variable annuities this year are likely to fall short of the record $137.5 billion recorded in 2000. But the market for variable annuities remains vibrant, competitive and full of innovation, according to representatives of the National Association for Variable Annuities who spoke at a recent seminar in New York.

In the first quarter this year, sales declined to $28 billion from $36.5 billion a year earlier, according to the Variable Annuity Research and Data Service (VARDS), Marietta, Ga., which has tracked the market since 1988 (see "Quarterly Variable Annuity Sales," page 98). Speakers at the NAVA seminar said the slowdown largely reflects the yearlong bear market in many stock-market sectors and correlates with that of mutual-fund sales as reported by the Investment Company Institute.

Annual variable-annuity sales most recently fell to $7.2 billion in 1988, when only about 25 contracts were available, offering about 300 subaccounts. Now, more than 60 carriers offer about 500 contracts with about 15,000 subaccount investment options, said David Shapiro, chief executive officer of Info-One, which acquired VARDS in 2000. In February, NAVA reached an agreement with Info-One's VARDS Data Collection Serto have the service collect standardized data about variable-annuity contracts, much as the Investment Company Institute collects data on mutual funds.

But while variable annuities are a robust industry, which held $878.8 billion in assets as of March 31 (see "Variable Annuity Annual Total Net Assets," page 100), cannibalization within the industry may account for many new sales. Jeffrey Oster, speaking at a conference co-sponsored by Lehman Bros. and A.M. Best Co. in May, said that in 2000, only 35% of the money put into new sales of fixed and variable annuities came from sources other than existing annuities. In contrast, about 92% of money in new sales in 1990 came from outside the industry, said Oster, president of New York-based Client Preservation & Marketing.

Oster said the turnover of annuity products is caused by intermediaries, usually employed by banks, wirehouses or brokerage firms, who collect new commissions when they move clients from an old annuity to a new one.

New Twists

Variable-annuity manufacturers are bringing many new features to the marketplace, and insurers that "don't keep current" face the risk of losing customers, Timothy Pfeifer, a principal with the consulting firm Milliman & Robertson, said during a presentation at the NAVA seminar.

Variable annuities are complex products with many parts. To enhance their competitive positions, product manufacturers have "unbundled," or broken out, those parts to provide choices to intermediaries and contract owners or to give them basic products with the lowest fees. Pfeifer said these unbundled product features are primarily death benefits or living benefits. The basic death benefit is the higher of return of principal or contract value. For an additional charge, insurers also offer a death benefit equal to the highest anniversary value or a guaranteed annual gain--typically 5% or 6% and capped at 200% over the life of the contract--or the higher of the two.

For example, Nationwide Life Insurance Co. recently paid a death benefit of $700,000 on a contract valued at $580,000 when the owner died, Shapiro said. The investments in the contract were badly hurt by the recent bear market in certain kinds of stocks, and the owner died only months after buying the annuity, he said.

About 30 to 35 companies offer expanded death-benefit guarantees, and the number is growing, Pfeifer said.

The hottest new benefit, designed to help in bull markets, is the earnings-enhancement benefit, which costs about 20 to 30 basis points annually. It adds a percentage, usually 20% to 40% of the death benefit, to help mitigate the income-tax liability of heirs. Unlike the death benefit of life insurance, an annuity's death benefit is taxable, but this earnings-enhancement benefit can be purchased without underwriting.

Staying Alive

Living benefits help the contract owner, not the beneficiaries. The most common is the guaranteed minimum income benefit for annuities in the deferred stage, which the owner intends to convert to a payout annuity. For a cost of 20 to 35 basis points annually, the value of the payouts will be based on a guaranteed compounded annual gain in the deferred phase-usually 5% to 6% or the actual performances of the underlying investments if they are higher. Pfeifer said about 25% to 30% of new customers choose this optional benefit.

The second-most popular living benefit is the guaranteed minimumaccumulation benefit, which guarantees at least a one-time bump-up in value equal to premiums plus some level of interest. The third-most common benefit is the guaranteed minimum payout floor in an immediate annuity. Payouts in an immediate annuity vary based on the underlying investments, but this benefit guarantees they will never fall below a certain percentage--say 85%--of the first payout.

Also available is the guaranteed minimum-withdrawal benefit, pioneered by Fortis, which allows a certain percentage of premium to be withdrawn every year without a surrender charge.

Governed by Competition

Annuity manufacturers earn some profit on these features, and they may use those profits to offset losses they incur elsewhere in their product design to gain market share, said Mark Mackey, president and chief executive officer of NAVA. "Overall, the companies are governed by the competitive market," Mackey said.

Bonus Benefits

It is clearly the competitive market that has driven product manufacturers to develop bonus variable annuities. These products pay a bonus of 1% to 6% to the buyer at the time of purchase. The bonuses are tiered, so higher percentages are paid to contract owners depositing more money. Companies make up for the bonuses over several years through higher charges in other parts of the annuity.

"Bonus annuities are best for the bullish policyholder," Pfeifer said. "If the market goes up, they can make money on the bonuses."

Mackey said companies developed bonus annuities not so much to encourage the buyer, but to entice agents to sell them. And with the stock market down so far now, some consumers may want to have the extra bonus money to invest in stocks while share prices are low, he added.

The Federal Securities and Exchange Commission last year expressed some concern about agents pushing potential buyers toward products they may not fully understand, but bonus annuities have won approval from the New York Department of Insurance. Pfeifer said the department requires that before any sale, prospects must understand that they can either gain or lose money on bonus annuities.

Product manufacturers also have ventured into the realm of packaging variable annuities with other benefits, Pfeifer said. John Hancock and Nationwide, for example, provide long-term-care benefits with products they have introduced since the beginning of last year, and other companies offer critical-illness benefits. Insurers also have increased tremendously the number and variety of subaccount investment choices.

Insurers are recognizing extraordinary potential for variable immediate annuities or for owners of deferred annuities to convert to the payout phase. According to a Milliman & Robertson survey, immediate variable-annuity sales increased by 75% last year over sales in 1999. "That increase was from a very small base, but the trend is going strongly now to expansion, and 2001 will be a very strong year," Pfeifer said. New designs, such as greater liquidity and the ability to commute the value of future payments, are making immediate annuities more appealing. With commutation, the insured's estate or beneficiaries will receive some of the contract's value if the insured dies. Insurers are applying those commutations not just to period-certain options, but to life-contingent options, Pfeifer said. Newer designs also offer minimum death benefits and other guarantees.

"There's a lot of design room on the payout side, and we're on the front end of it," Pfeifer said.

Variable Annuity Annual Total Net Assets
The recent downturn in the stock market is eroding the value of
variable annuities
($Billions)
1991    $176.0
1992    $211.6
1993    $267.5
1994    $313.3
1995    $400.3
1996    $503.6
1997    $640.2
1998    $783.4
1999    $987.1
2000    $972.6
2001 *  $878.8
(*)Through 3/31/01
Sources: VARDS; Info-One
Note: Table made from bar graph

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