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Challenges to the annuity industry.

Life insurance companies must minimize the risk of disintermediation. This happens when deferred annuity holders seeking higher-yielding alternatives withdraw funds prematurely (often during periods of increasing interest rates), and force companies to pay these surrenders by liquidating investments that may be in an unrealized loss position. Insurers can mitigate this risk by matching the duration of its interest-sensitive liability portfolio with the duration of its asset portfolio, and by selling a diversified portfolio of products. Insurers also mitigate risk by designing deferred annuities with market-value adjustments on surrender values.

Immediate Annuities: These annuities are designed to guarantee owners a predetermined income stream on a monthly, quarterly, semiannual or annual basis in exchange for a lump sum. Options are limited from the annuity holder's perspective, so profits are generally less volatile in the short term. However, the long-term nature of these products exposes the insurer to reinvestment risk and longevity risk.

Group Annuities: These differ slightly from individual annuities in that the payout is dependent upon the life expectancy of all the members of the group rather than on the individual. Many company retirement plans, such as 401(k) plans, are annuities that will pay a regular income to the retiree. Tax-deferred annuity plans--403(b) and 457 plans-- also are used widely by public-sector and nonprofit workers.

Deferred Annuities: A type of long-term savings product that allows assets to grow tax-deferred until annuitization. This product category includes:

Traditional Fixed Annuities: These products guarantee a minimum rate of interest during the time the account is growing, and typically guarantee a minimum benefit upon annuitization

For the issuer, fixed annuities are subject to significant asset/liability mismatch risks, as described above. Also, when interest rates fall, spread earnings--or the difference between the yield on investments and credited rates--can decrease, and asset cash flows must be reinvested at lower rates.

Fixed-Indexed Annuities: These products are credited with a return that is based on changes in an equity index. The insurance company typically guarantees a minimum return. Payouts may be periodic or in a lump sum. The potential for gains is an attractive feature during favorable market conditions; however, gains may not be as favorable as those available from variable annuities or straight equity investments. Sales of these products may decline if equity markets go through a prolonged downturn or a prolonged upturn.

Variable Annuities: The participant is given a range of investment options, typically mutual funds, from which to choose. The rate of return on the purchase payment, and the amount of the periodic payments, will vary depending on the performance of the selected investments and the level of expense charges in the product.

Variable annuity sales tend to slump during unfavorable equity market conditions. In addition, the primary sources of revenue for these products are account-value-based fees, which also decline when market conditions deteriorate. Relatively thin margins, increasing product complexity (e.g., guaranteed living benefits) and volatile capital requirements put variable annuities at the riskier end of the product continuum, from the standpoint of the issuing insurer.

Because variable annuities allow for investments in equity and fixed-income securities, they are regulated by the U.S. Securities and Exchange Commission. Fixed annuities and fixed-indexed annuities are not securities, and as such, are not regulated by the SEC.
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Title Annotation:CHAPTER 3: LIFE
Publication:Best's Review
Date:Nov 1, 2016
Previous Article:Important lines of life business and products.
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