Low Interest Rates Hurt VA Sales, Spur Changes

September 12, 2012

By Linda Koco

Variable annuity insurers haven’t been sitting back twiddling their thumbs this last quarter, even though sales have slumped. 

More than half of the nearly 40 carriers in the Morningstar variable annuity database filed for 168 changes in their products in second quarter, according to John McCarthy, product manager-annuity solutions for the Chicago researcher.

That’s well above the 59 filings made in first quarter 2012 and slightly above the 162 recorded in the second quarter of last year, he says.

The changes read like a story-board of how carriers are responding to the tough economy. For example, 57 of the second quarter changes involved closure of existing contracts, and 23 involved closure of existing benefits. There were 11 product revisions, too, and also seven fee changes.

Carriers were taking active steps to maintain profitability during the prolonged low-interest rate environment, McCarthy explains.

With interest rates at record lows, it has been difficult for carriers to continue supporting living benefit guarantees designed for a higher interest rate environment. Hence the cuts to certain products and features, the fee increases and the product revisions.

New contracts, too

But the Morningstar report shows something else too. Thirty-seven of the second quarter filings involved new contracts, and 33 involved new benefit features. So the carriers aren’t abandoning the market. Many are debuting new contracts designed for today’s environment.

Even here, however, strains of the tough economy have filtered through. For instance, “a number of carriers tweaked the guaranteed lifetime withdrawal benefit (GLWB) features in their products,” McCarthy says.

By tweaking, McCarthy means the carriers cut back on certain provisions. Some reduced the guaranteed lifetime withdrawal percentage that their products offer, a process that began at many variable annuity carriers following the start of the Great Recession in 2008.

The new withdrawal percentages now range between 5 and 7 percent, McCarthy says. That’s down from a high of 10 percent in 2007-2008.

Some carriers have been increasing the fees they charge for the GLWB roll-up feature, as well. (This feature determines the percentage increases the carrier will make to the annuity base value, which is used in computing the guaranteed withdrawal amount). The average in fees for this feature has been rising for the last three or four quarters, McCarthy says.

Damper on sales

Changes like this have put a damper on sales growth. In the first half, new sales reached $73.5 billion, about 48 percent of 2011’s full-year new sales total, Morningstar says. (“New sales” refers to gross dollars going into the products.)

That means there is a strong possibility that variable annuity sales will end the year flat or slightly down — unless there is a significant uptick in the second half, McCarthy predicts.

In second quarter 2012, new sales did trend up 5.5 percent over first quarter, he allows. They rose to $37.7 billion from $35.8 billion. But compared to the new sales total of $39.4 billion in second quarter 2011, this year’s second quarter was down by 4.6 percent.

Second quarter 2011 was the highest quarter the industry has seen in three years, McCarthy says.

There are a number of reasons for the projected flat-lining in sales, but McCarthy’s overall view is that carriers really want to limit exposure to risk by managing growth in their variable annuity sales.

Managing growth includes adjusting features and percentages in the products that serve as incentives. “Some, like MetLife, have stated publicly that they want to control variable annuity growth so as to manage the risk of their overall insurance portfolio,” McCarthy says.

The resistance of advisors and consumers to some of the product restrictions play a role, too. For instance, the newer withdrawal rate guarantees of 5 percent or 5.5 percent may sound fairly modest to some people, so they may not be interested.

Actually, McCarthy says, in today’s low-interest rate environment, “Rates like that are pretty attractive.”

With all the changes that variable annuity carriers have already made in their products to ensure profitability, there don’t seem to be many more levers the carriers can pull in order to meet profitability objectives, McCarthy says.

In the fixed indexed annuity business, some carriers have been reducing commissions for just this reason. But McCarthy says he has not heard of that happening in the variable annuity market. Morningstar doesn’t track commissions, but if haircuts are in the air, the company often hears rumblings about it. “I heard some rumbling a couple of years ago, but nothing recently,” he says.

Companies typically use commission cuts to limit sales, he points out. So companies that want to rein in on sales might turn to that at some point.

The “I-share” surprise

Surprisingly, despite the trend to introduce more limitations on product features and provisions, some variable annuity carriers are looking for new revenue opportunities.

This is evident in the rise of the so-called “I-share” variable annuities.  Morningstar reports that, at the end of the first half 2012, there were 55 I-share contracts in its database of more than 500 available variable annuities. That’s up from 34 I-share annuities one year ago. 

The number of companies now offering I-share contracts is 22, Morningstar says.

I-share variable annuities are extremely low-cost products, with total fees ranging from 30 to 80 basis points and surrender charge period that run about eight years. “They are like tax-deferred shells with cutting edge investment strategies,” McCarthy says.  (They have nothing to do with iShares, the family of exchange-traded funds managed by BlackRock.) 

Companies that have capacity for more variable annuity sales could be using these products to spur sales from fee-based registered investment advisors, he adds.

Still, it’s a niche market right now, and only 3 percent of variable annuity sales go into I-share products. So, even if they double the carriers’ sales volume through I-share contracts, “it won’t affect industry sales in a big way or dramatically affect the risk exposure of the companies that sell them,” adds McCarthy.

The product development here could be an activity for the carriers to pursue, while “the wait continues for interest rates to rise,” he says.

Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at linda.koco@innfeedback.com.