Continued low interest rates. Possible regulatory and accounting changes. An economy that is both volatile and sluggish at the same time. All those factors make it tough sledding for the annuity industry nowadays.
Recently, Ernst & Young outlined the challenges the life insurance and annuity industry faces in 2012. Top on the list was the persistent low-interest rate environment insurers now confront that shows no signs of making an upswing anytime soon.
In an interview with LifeHealthPro, Doug French (right), managing principal of the insurance actuarial advisory service at E&Y, elaborated on that outlook and what annuity insurers can do to meet those challenges.
What’s the biggest challenge facing the industry today?
By far the biggest issue facing the insurance industry today is the low interest-rate environment. Everyone has an opinion on where interest rates are going, but you have pretty strong indications from the Fed that rates will remain low to mid-2013, maybe further out. So you will continue to have spread compression. Now, everyone has an opinion on how [long] interest rates will stay low, but it’s anybody’s guess. The other issue is if I’m an insurance company, if interest rates begin to rise, and they rise quite quickly, then I have disintermediation risk. I’ve got another set of problems because I’ve got people who can go and buy products at new money rates higher than my portfolio rates and you know what happens‑everybody leaves and moves next door. And hence, that puts pressure on liquidity.
What can insurance companies do to overcome those challenges?
I don’t know if you can overcome it. You certainly have to be more aware of it. I think you are going to have to sharpen your focus on your ALM (asset liability management) positions and make sure you understand that. I think you may have to ration product. I don’t think you can sell unlimited product and put unlimited strain on your balance sheet. You are certainly going to have to go to the state regulators and try to get the lowest non-forfeiture rates you can get and refile your products.
You can look at alternative asset classes, but with alternative asset classes, there’s a risk-reward trade-off so you need to be careful with that. There is no easy solution. There is no magic bullet, because you still need to sell product. The customer still needs product. The customer buys guarantees because they need guarantees. You just have to be razor sharp in managing those guarantees going forward.
If we go back a couple of years, and we were sitting in this same low interest rate environment you could convince yourself, “I’m going to be alright if interest rates go up.” That’s what everybody said, “Well, interest rates will go up. I’ve got some short-term pain, but interest rates will go up and things will be fine.” Well, here we are today. We know interest rates aren’t going up anytime soon. It’s a different challenge. You have to face reality; you have to be careful with your balance sheet.
The variable annuities that people want to buy have options and guarantees embedded in them, whether they’re guaranteed death benefits or guaranteed income benefits or guaranteed withdrawal benefits. Hedging those risks becomes pretty expensive in a volatile economic environment, mostly because of the equity markets and where the equity markets are moving. You’ve seen in the past couple of years, there has been some pretty dramatic swings in the equity markets, not only day to day, month to month, but quarter to quarter. Also, if you’re going to give somebody a variable annuity with a 5 percent rollup guarantee, are you going to make 5 percent in the equity market for the next 20 years? Maybe five to six years ago you’d convince yourself over time you would. I’m not sure you would today. A lot of these contracts that were sold years ago are in the money.
What can variable providers do?
I don’t think you’ve seen the end of the shakeout of who’s staying and who’s going. I think variable players are de-risking their products. I think they are putting risk-management features inside their products. They are reducing the guarantees they offer the customer and you will see [carriers] ration product. I think they will sell a certain amount of product in a year and when they hit that amount, they are not going to sell anymore. They, in effect, are going to take themselves out of the market. You just can’t take unlimited risks in today’s environment. It’s too choppy, it’s too risky.
Maria Wood is the annuity channel editor for LifeHealthPro.com and managing editor of Senior Market Advisor.