The headlines would leave any advisor‑or consumer‑a bit confused. In the span of several weeks, two large carriers announced their exits from the variable annuity (VA) business and another took a large hit on their earnings due to a previous closure of the product line. Yet at the same time, reports documented a rise in VA sales.
So, what gives? And what impact would those exits have on variable annuity sales in the U.S.? Would these moves change how advisors sell annuities? Would consumers have less choice in annuity products?
First, some background: In December, Sun Life announced it was discontinuing sales of VAs in the U.S. Also in the same month, ING reported a $1.1 billion hit to its fourth-quarter earnings due to a VA block of business it closed in the U.S. back in 2009. In addition, John Hancock said it was "restructuring" its annuity business.
Editor's Note: Beth McGoldrick, assistant vice president of public relations for John Hancock Financial Services, sent this statement to LifeHealthPro: "Due to volatile equity markets and the historically low interest rate environment that is expected to continue for an extended period of time, John Hancock is restructuring its annuity business. Going forward, our current annuities will be sold only through a narrow group of key partners such as John Hancock Financial Network. John Hancock will continue its award-winning service to its annuity clients, who will see no change in how their accounts are handled."
Meanwhile, the Insured Retirement Institute (IRI) reported that net VA sales in the third quarter hit $8.9 billion, a 38 percent rise from the same quarter a year ago and the highest level since 2007.
So why would any carrier turn away from a seemingly lucrative product line?
Much of the turnaround relates to where those carriers are domiciled. ING is based in the Netherlands while John Hancock and Sun Life have Canadian parent companies. As such, those offshore entities operate under different reserve and reporting requirements.
In particular, ING must contend with Europe’s Solvency II requirements, which mandate greater capital reserves, according to Cathy Weatherford, IRI’s president and CEO.
Those new requirements, coupled with market volatility and low interest rates, have forced some companies to rethink their strategies around the VA product, she says.
She does not envision U.S. carriers exiting the business in kind, partly because she maintains the reserve requirements in the U.S. are already equivalent to the Europe’s Solvency II mandates.
“I think each individual carrier makes their own decision based on their own business and distribution models, so I don’t think there is any wholesale answer around this question,” Weatherford says. “But I do believe we are seeing the highest sales since before the meltdown in 2007 this year. So clearly there is available product and advisors and consumers are gravitating toward them.”
What’s more, Weatherford says that carriers are adjusting their product designs to address prevailing market realities.
“We’ve seen significant product retooling over the past three years. We’ve seen significant hedging strategies,” she details. “Many have the ability now to move the money to less volatile fixed incomes if they start seeing market volatility. We know the living benefits aren’t quite as rich as they used to be. They’ve retooled them in a way that they are comfortable with. First and foremost in every insurer’s mind is that they want to be sure they have absolute financial strength so they can perform on the promises they’ve made to policyholders in the products they deliver.”
Which means that consumers and advisors should expect to have a variety of VAs to choose from, Weatherford says.
“We have strong carriers who have a robust product suite,” she says. “We’ve seen different strategies with low fees. So I think there are lots of options and opportunities for advisors and consumers.”
Robert Schmansky, CFP, founder of Clear Financial Advisors, LLC, in Bloomfield, Hills, Mich., is no fan of variable annuities. Yet he contends the exits by major carriers won’t have much impact on the marketplace for the product.
“It does expose that there is more risk out there than we may have previously thought,” he says. “But I think consumers who have purchased them are buying into a story. So I don’t know that the consumer that uses an advisor that believes in these products is necessarily going to make a move. I think it’s probably going to lead to more people choosing equity indexed annuities just because they offer a similar type story in that you can participate in the markets and not take on risk. I think those are probably similarly flawed.”
Although he could only speculate on why the aforementioned companies exited the business, Schmansky recalls that when VAs became popular a few years ago, carriers raced each other to provide better and better benefits. Then, the market took a tumble.
“I don’t think they expected 2008 to roll around,” he says. “When it did, their response was to increase fees and cut back on benefits. This is just the next natural step [since] they’ve potentially got liabilities.” He further predicts that more carriers will be “clamping down” on investments options in VAs.
VAs sold at the top of the cycle offered generous benefits, Schmansky points out. When the market tanked, real account balances dropped, yet benefits are guaranteed. “Technically, that’s where the insurance guarantees kick in,” he says. “The insurance company, of course, wants to only refund you your own money but there is a real chance that if values don’t come back, they are on the hook for more than they thought they were.”
If a client came to him with a variable annuity that no longer was suitable for him or her, Schmansky says he would advise doing a 1035 exchange into a “low-cost, no frills” annuity that provides better diversification. “There are a few annuities good for that, but not too many,” he states.
Michael Ham, a frequent blogger on annuity topics for LifeHealthPro, writes in email comments that the exit of large carriers from the VA business is unlikely to hurt consumers who already own the product or advisors who want to offer them. Dallas-based Ham is a financial planner and founder and president of J. Michael Advisors and TheSalesTalk.com.
What is coming back to haunt some carriers, Ham asserts, are the very same features that make VAs attractive to consumers: the guaranteed living or income benefits that insurers are contractually bound to provide. Therefore, if an insurer estimates that it may not be able to deliver on those guarantees, it’s wise to walk away from the product line.
“In fact, their actions of leaving the riskier variable business line strengthen the guarantee promised upon contract issue,” Ham writes. “The insurance company’s task is not to predict the future but to prepare for the worst-case scenarios that banks and Wall Street failed to do leading up to the financial crisis in 2008. Better safe than sorry.”
Similar to Weatherford, Ham points out that the companies that are abandoning the VA product line are based outside the U.S.
“Europe is in a total mess and the euro has the potential to evaporate as a currency,” he writes. “The U.S. dollar has strengthened and the yield on the 10-year Treasury bond has a real possibility of hitting 1.5 percent. Many of the index annuity products have announced commission reductions and income rider bonus rate cuts, effective January 2012; but not so much in the variable annuity product realm. Income benefits and compensation are basically unchanged.”
Just because a few players have left the game doesn’t mean the entire VA universe is headed for a fall, Ham maintains. “The good news is there are still many awesome variable annuity products available from large, secure carriers that made judicious and prudent product decisions years ago.”