By Sheryl Moore
The negative stigma surrounding indexed annuities has certainly lessened over the past few years. However, indexed annuities aren’t exactly in “the good graces” of the entire insurance industry. Sure, the media has been illuminated on the relatively few problems in the market and the Securities and Exchange Commission’s Rule 151A is almost out-of-sight in the rearview mirror. However, large insurance companies that sell variable annuities (VAs) tend to hold a grudge against these “safe money” products.
That being the case, why are so many new (traditionally VA) companies diving into the indexed annuity market? In the third quarter of 2011 alone, three new carriers decided to try their hand in index-linked annuities and there are more than twice as many companies still waiting on the wings. To understand the motivation for this recent shift to indexed, you must first understand how market conditions affect sales of interest-sensitive products.
The thing about hitting “rock bottom” is that you can’t get any lower, right? Well, what happens when the stock market hits rock bottom? It begins to recover and subsequently increases. It makes sense then that when the market rallies, sales of securities products go up. Securities products that give investors the opportunity to earn gains as a result of market performance are very popular when the stock market is on the rise because investors want to be able to take advantage of the market’s increases and have an opportunity to share in the gains.
That being said, it is not surprising to see sales of VAs increase when the market begins to recover from a loss. In fact, VA sales experienced consistent annual increases after the market’s collapse at the turn-of-the-century. Increases in VA sales ranged from 3 percent to 17 percent from 2000 to 2007, when the market buckled again. Overall, it is not unusual to see consumers transfer their fixed money assets to securities products when the market is on the rise.
On the other hand, when there is a decline in the stock market, such as what we witnessed in the years 2000 and 2008, there is a corresponding decline in sales of securities products. Financial instruments such as stocks, bonds, and variable annuities have sales that are a function of market performance; when the market declines, sales drop because of investors’ fear of losing money. A decline in the markets translates to a loss of gains, and sometimes a loss of principal too. Suffering from market declines in such an environment provides a stark reminder of how uncomfortable it feels to lose money.
For that reason, it is understandable to see sales of VAs decline when the market begins to spiral downward. Here's an example: the last time the stock market took a dive was in 2008. Consumers that owned variable annuities begin moving out of equities and acquiring fixed and indexed annuities at that time. In fact, variable annuity sales dropped more than 15 percent in 2008 and another 18 percent in 2009. At the same time, sales of fixed annuities rose more than 70 percent in 2008 and indexed annuity sales saw a 6 percent increase in 2008 as well as a gain of nearly 13 percent in 2009. It is also worth noting that the period following market declines is also conducive to consumers transferring their securities into fixed money instruments.
Increases in Fixed Interest Rates
Fixed interest rates also play into this equation. When there is an increase in fixed interest rates, products such as fixed annuities and certificates of deposit (CDs) see a corresponding rise in sales. Such products are overwhelmingly commoditized. These sales are a pure function of the interest rate environment.
When rates increase, sales of these products also increase because of the promise to get “something better” than what the purchaser already owns. Anyone who remembers double-digit CD and fixed annuity rates knows what I am talking about here. In fact, this is why we often see a rise in fixed annuity 1035 exchanges and CD rollovers when interest rates are on the increase.
Declines in Fixed Interest Rates
Likewise, when interest rates fall, we also see a reduction in sales of fixed money instruments. Purchasers are always looking for the instrument that can provide them with the greatest gain. Because of their commoditization, fixed annuities and CDs aren’t extremely appealing when interest rates drop.
This environment often results in consumers “holding on” to their fixed assets and avoiding cash surrenders and 1035 exchanges when interest rates decline. Fixed annuity rates have steadily declined since hitting an average 5.43 percent in 2008 and CD rates have declined steadily since hitting an average 1.82 percent credited rate in 2009. A decline in fixed interest rates can also translate to a transition to securities products, where consumers have an opportunity to experience relatively competitive gains.
Now, you understand how these different environmental conditions affect sales of interest sensitive products. But, what happens if we look at a combination of these environmental factors?
The downward movement of the stock market can have a negative effect on the VA purchaser’s future retirement plans. Preservation of principal suddenly becomes important, once you’ve just lost nearly 50 percent of your retirement fund. For insurance companies selling VAs, this phenomenon is usually no cause for alarm because although their VA assets decline during such occasions, their fixed assets experience a corresponding increase. In essence, annuity sales are like a see-saw with fixed annuities on one seat of the teeter-totter and variable annuities on the other. Sure, one side might go down. But, when it does, the other side goes up.
So what happens when fixed interest rates are in the gutter too?
Indexed annuities will become the natural beneficiary of such a market environment. This is great news for the insurance companies underwriting indexed annuities. On the other hand, it is not so comforting for insurance companies that have historically bad-mouthed indexed annuities. If they don’t want their VA assets to fly out the door in the wake of market uncertainty because their fixed interest rates are depressed, they'll have to consider developing a product that they once scorned.
So don’t be surprised as you continue to see very large, old and highly-rated insurance companies that you thought hated indexed annuities suddenly introducing them to their distribution. After all, the old adage remains true: “If you can’t beat ‘em, join ‘em!’
Sheryl Moore is President and CEO of AnnuitySpecs.com and LifeSpecs.com, indexed product resources in Des Moines, Iowa. She has over a decade of experience working with indexed products and provides competitive intelligence, market research, product development, consulting services and insight to select financial services companies. She may be reached at [email protected].
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