Investment (variable) annuity companies are having problems, again. Why? Because it’s tough for a life insurer to make money when the 10-year bond rate — manna for life insurers — hovers around 2%. So long as bond rates are held artificially low by government policy, there may not be much improvement possible for life insurers until 2013, when the interest-rate guardrails are removed.
Sun Life Financial — which offered an income benefit that increased yearly, regardless of market performance — has given up the ghost and gotten out of the biz. It will, company executives say, focus instead on worksite marketing. Of course, Sun — no relation to SunAmerica — is owned by Sun Life of Canada. The $450 billion Canadian insurer also owns MFS, the mutual fund company, which has, at last report, some $253 billion in assets under management. As to Sun’s exiting the investment annuity business, part of the reason cited was that reserving requirements in Canada are tougher than they are in the states.
The company will continue to serve its existing customer base, and says, on its website: “The decision to stop selling variable annuity and individual life products in the U.S. will not impact existing customers and their policies. The company will continue to provide quality service to its policyholders, while focusing on the profitability, capital efficiency and risk management of the in-force business.”
Given the housing and credit crises in 2007-08, many companies modified income benefits. One insurer took a kind of sabbatical, shutting everything down temporarily, only to return months later. This is the second time Sun Life has exited the investment annuity business. Since building a sales network is hard and expensive, one academic suggested that the company may never make a third try. I suspect that he is right — reps have l-o-n-g memories — and Sun Life will probably stay away from investment annuities for ages.
Modifiers
Technically, Sun Life Financial is the second company to stop investment annuity operations currently. The other company was John Hancock, which was also subject to harsher reserving requirements because its parent is a Canadian company.
Sun Life is not alone in its concerns. Other companies have modified or tightened income benefit offerings. While Prudential has been remarkably consistent in its HD series of annuities, it does make modifications as situations change. I think its current offering is Lifetime 5, meaning the income benefit tracks the highest daily value at a 5% compound rate. The stock markets are open about 250 days yearly (there is some difference from year to year, depending on which days some holidays fall). At each Pru annuity’s anniversary date, the company looks backwards and picks the highest daily value day, then compounds it at 5% for the balance of the year. If your customer bought a Lifetime 5 product on January 1, and the sub-accounts you and he or she selected had a high the next day — January 2 — Pru would compound from January 2 through December 31. If the market high was December 29, though, the compounding would only be for a few days. This compounding happens each year.
Please keep in mind that this discussion is about income benefits, and income benefits are not cash money — instead, they are a non-cash amount on which lifetime income is based. To be extreme, one could have, say, a few thousand in real money in an investment annuity and still have an income base of $100,000 or more. One could never get at the income base in cash — it’s like a ship that never touches shore — but monthly or annual income will flow from the income base for one lifetime (or two, if the annuitants or owners are husband and wife).
Pru tightens by reducing the compounding factor — in other words, Lifetime 5 was once Lifetime 7, and, before that, for a time, Lifetime 6. Pru also contracts obligations by discontinuing benefit multipliers — provisions like “ there will be no less than a doubling of income benefit in 10 years, a trebling in 15 and a quadrupling in 20.” Pru eventually deleted some of those offerings.
Overall, though, Prudential has been a consistent player in the income benefit arena, as has Jackson National and MetLife. All three companies deserve a great deal of credit for maintaining stability during the crisis. Neither made changes that would drive wholesalers and reps crazy. MetLife is a company that actually may have improved its offerings in 2007 and 2008 — there was no mid-panic in the middle of the crisis. Although it has had some recent changes, it still offers good lifetime income benefits.
During the crisis, other companies changed benefit structures, some for the better. Transamerica now offers monthly resets for its income benefit. Allianz provides possible increases in income benefits and quarterly income base ratchets. Pacific Life offers a robust collection of sub-accounts with basic income benefits. These three companies — and more — had to reinvent income wheels after the 2008 crunch. AXA Equitable, one of the originators of the concept, changed the whole income benefit enchilada for one of its products, offering a minimum of 4% or the market value, during accumulation and a lifetime promised income that ranges from 4% to 8% when income is taken, depending on the 10-year treasury rate, plus an add-on. The other Sun — SunAmerica — figured out that people really need more money when they first retire and so modified its lifetime benefits accordingly. Now, the initial benefit is high, but it can shrink a bit later.
What’s the issue?
If bonds are paying a 2% yield and an insurance company is collecting an M&E charge of, say, 3.25% from an investment annuity owner, there’s little profit room. At the 2% bond yield, plus the M&E, the company is, in this example, collecting 5.25%. That sounds fine, but only until the realization hits that commissions must be paid, the company must recruit, train and manage wholesalers (not a cheap thing), pay its home office expenses, pay for trading costs, relate the income to actual expected claims, and still earn a profit. If a broker takes his or her compensation upfront, say, at 6%, the company is behind the eight-ball at the get-go. And it has this huge future income benefit obligation, typically handled by reserving — funds reserved are managed more conservatively and earn less — reinsuring and hedging, all of which cost money. Some picture, right? It’s not all sunshine; there are clouds, too.
To make things worse, reinsurers get nervous when the thought that they could be on the hook for significant liabilities appears. During such times, they have sometimes refused to sell insurers coverage.
And the future benefits have future costs — for administration and lifetime income promises. In other words, money needs to be present when needed.
Pay-to-play
It’s true that a company may earn pay-to-play income from sub-account managers. However, this income is likely more than offset by the dollar sums that large investment annuity writers cede to broker-dealers for convention and meeting expenses, a different kind of pay-to-play. Sometimes, annuity companies pay relatively large sums to wire houses, too, in order to gain access to reps, even when the annuity company in question earns most of its income from a different channel.
The Rocky Light Insurance Company, for example, may provide extra financial support to a large wire house, Muckle, Duckle, Chuckle and Turnip. MDCT writes a large amount of investment annuity business for Rocky Light. So there is a kind of logic at work when Rocky Light writes a large check to MDCT each year. Separately, Marigold Life wants access to MDCT reps for its investment annuity. So it, too, writes MDCT a large check each year and has a booth at the MDCT annual meeting, even though, unlike Rocky Light, it gets most of its revenue, 70% or more, from the independent financial planning channel.
Even though it really does not make much from MDCT, Marigold wants to be there. If you ask the Marigold execs, they will tell you that they do it for “competitive reasons.” Good luck with trying to understand that answer, since Marigold has never come close to figuring out how to make money with MDCT (or any wire house, for that matter) reps. Indeed, in 2008, Rocky Light was one of the first life insurers to exit the business. Why did RL discontinue its annuity? I think it was because the MDCT reps (and other wire house reps) used Rocky Light extensively and took most sales compensation — then around 7% — upfront. Plus, RL had to produce an ever-larger check each year for MDCT for pay-to-play expense. Add Rocky Light wholesaler salaries, bonus compensation and expense accounts, combined with bond losses, and it’s a mess. When the 2007-2008 trouble hit, Rocky Light headed for the exit.
I get a headache every time I think about pay-to-play logic. Why would any company in its right mind put more money into wire houses — where it’s tough to make profit — when it could put it into the financial planning and bank channels and get better persistency and far greater net gain?
What is known in late December is that Sun Life Financial has exited the investment annuity business. This does not mean that Sun Life will not provide benefits for existing investment annuity owners and annuitants going forward. Sun of Canada enjoys an excellent reputation, and anyone lucky enough to have its income benefit package will, I’m sure, have a good future benefit outcome.
Sun Life may be the first new investment annuity domino to fall, and may not be the last. Given economies of scale, it seems better to have a big book of investment annuity business and off-setting life business. That way, the smaller books of business may have relatively more trouble. It is not likely that volatility will improve in the short term. And it is equally not likely that — given the artificial guardrails — that bond yields will improve much for a while. It will require great skill and patience for investment annuity companies to navigate the shark-infested waters of low bond prices and high costs.
For the sake of all the advisors who have built investment annuities into a trillion-dollar market, I wish the company captains smooth sailing.
This information is intended for financial professionals only, not the general public. This is not a solicitation to buy or sell any specific security. Mr. Hoe may have positions in the securities or other investments discussed. Investments in securities do not offer a fixed rate of return. Principal, yield and/or share price will fluctuate with changes in market conditions, and when sold or redeemed, one may receive more or less than originally invested.
