By Steven A. Morelli
Reprinted from the December 2012 edition of InsuranceNewsNet magazine.
Step back from The Cliff. Let’s talk about how 2013 could be a lucky year.
It might be difficult to turn away as you look down, mesmerized by all that trouble roiling below, but let’s back up and chat about this. Yes, 2013 has the promise of being as unlucky a ’13 as a 13 can be. Of course, we didn’t have high hopes for 2012 and that turned out to be true. Then you have people who say that 2012 was just setting us up for a new year of bumper cars played with tractor trailers.
Oh, there you go looking down that cliff again. Maybe we should first review what’s churning our future and stomachs:
- Interest rates: The insurance industry runs on interest rates. The rock bottom rates for the past several years have drained fuel from companies, a significant factor affecting products. Rates are expected to remain low for at least the next few years.
- Capital requirements: Many factors have insurance companies worried about their reserves, and returns for that matter. This has already had an effect on products, a trend that is expected to accelerate.
- Regulation: Here is an area that the election probably did affect more than others listed here. If Republicans had taken the White House and the Senate along with the House of Representatives, which they already had, odds are good that the Dodd-Frank financial reform law would have been escorted out of the building. But regulators will be defining this law with renewed fervor, which has potential impact on how many advisors will do business.
- Tax treatment: As the nation careens toward the fiscal cliff, Republicans and Democrats are still far apart on spending cuts and revenue, but they agree on one thing: Revenue has to increase. That puts the target on tax treatment that the insurance industry has come to depend on.
- Estate tax cliff: Contributing Editor Linda Koco covered this very well in the November edition of InsuranceNewsNet Magazine, and this remains one of the top issues for our industry. Typically, estate taxes are not discussed when the subject turns to the fiscal cliff, but the impact would be significant for our industry because it would affect anyone with even a moderate net worth. This also is a key area of opportunity for insurance producers.
- The fiscal cliff: This is the combination of automatic, drastic spending cuts and tax cut expirations taking place at the end of this month. It will mean a lot less money for people to invest or pump back into the economy. If somehow by miracle or accident a deal is struck, more permanent tax reform will still be coming.
- Demographics: The insurance sales force is aging, as are the clients. So, not only are fewer families covered but fewer agents are selling because younger producers tend to become financial planners. Of course, the opportunity side of demographics is the constantly growing need for insurance products to protect retirement financing.
All in all, it makes a person almost hope the Mayan calendar is right about the end of time coming on
This year has the potential of affecting insurance producers in the two ways that matter most: how they do business and what they have to sell.
Interest Rates and Capital Requirements
Companies are recrafting products and sometimes abandoning them altogether because of interest rates and tougher capital requirements. The prolonged low rates and promises of higher returns imbedded in many longstanding policies and contracts have companies talking quietly about preventing what until recently has been an Asian phenomenon – the negative spread. Guarantees are the most vulnerable element, even though they have been driving sales growth in the wake of the 2008 crash.
When variable annuities sagged in sales, withdrawal guarantees helped fortify the products. As universal life policies evaporated from drained cash value, no-lapse guarantees saved the day. Then, underlying every policy from the stalwart term life to every insurance and annuity innovation since, is the promise of decades-long sustainability. All of that is endangered.
At LIMRA’s annual meeting in October, CEO Robert Kerzner laid it out in stark terms.
“Our data has shown for years that people look to our industry for guarantees; this is how we have differentiated ourselves and carved out our niche in the savings space,” Kerzner said before turning to some sobering predictions. “There won’t be 30-year guarantees on term. A UL with guarantees may become something that is displayed at the Smithsonian.”
He described the many pressure points on the industry, but he also pointed out that consumers bear the biggest impact.
“At a time when more Americans are underinsured, or not insured at all, the products they want may be disappearing,” Kerzner said, warning of an impending storm for the industry at the Chicago meeting, just as Hurricane Sandy approached the East Coast.
Low interest rates are the chief culprit in the pressure on products. Just when you think they can’t go any lower, rates find a new low. From an all-time high of 15.54 percent in 1981, interest rates have tumbled down a 31-year slope to the historic low of 1.62 percent in September, according to Kerzner. This makes it difficult for careful investors, such as insurance companies, to make money. Even though the historically low rate has made insurance guarantees a relative bargain for consumers, companies cannot sustain those promises. That means they have to cut not only the return but also the duration of policies.
The Hartford Financial Services Group said in 2010 if rates remained low, the company could expect to lose more than $130 million annually. After a few rough years, in 2012 the company sold its annuity business to Forethought, its individual life division to Prudential and retirement plan unit to MassMutual. It’s an extreme example of what many companies are doing.
This next year promises to bring more of the same, with fewer and stingier guarantees being offered and more companies exiting products altogether, with long-term-care insurance and variable annuities taking the biggest hits so far.
A lot can be lumped under this category but each of these issues could be an article in itself.
Because we were just on the subject of guarantees, it makes sense to look at an alphanumeric you will be hearing a lot more about in the next few months -- AG 38. That stands for the National Association of Insurance Commissioners’ Actuarial Guidance 38, which requires more reserves supporting no-lapse guarantees, starting Jan. 1. Many companies have boosted UL with secondary guarantees by double-digit percentages. At least one company, ING, has suspended sales.
That hurts many producers and marketing organizations because those UL products have been a standard for years. They made a compelling message to consumers, particularly since the crash, because cash value helped save many families and businesses.
The election also re-energized efforts to fill in details of regulations such as Dodd-Frank Financial Reform. Of particular concern is the fiduciary standard and the tug-of-war between commission- and fee-based practitioners.
Susan Voss, the Iowa insurance commissioner who also oversees securities, said she is concerned about the fate of insurance regulation in Washington, D.C.
“There is a lot of conversation at the federal level about all the financial systems, and when you have such a bank-centric approach, as they do in the beltway, it’s really hard for them to understand that other systems may not be the same,” said Voss, who is stepping down as commissioner at the end of the year. “But I think there’s always going to be this push to have more centralized oversight of these major enterprises.”
Voss has a unique perspective as a commissioner in state-based insurance who was also the 2011 chairperson of the National Association of Insurance Commissioners (NAIC).
“What worries me is that we’ve had a long ongoing discussion about multiple regulations and too many regulators and not enough uniformity,” Voss said. “It’s the sense that the federal government has an answer, and yet as a regulator I deal with the Federal Reserve, the FDIC, the FCC, Treasury, the Department of Agriculture on crop insurance, FEMA on flood insurance, and then you add Congress and the White House. So, we’re going from a belief that we’re leaving a multiple system to a uniform system, and it really isn’t.”
Voss spoke about the United States being pressured to conform to global standards, which can be good but also bad for the independent insurance channel. Kerzner said in his annual address that many other countries, especially in the European Union, don’t look upon commission-based business too fondly.
“Regulators worldwide have a belief that commissions are bad. We are seeing an alarming trend by regulators to take increasingly aggressive actions,” Kerzner said as he listed European Union countries that either banned or are planning to ban commissions.
On the licensing front, Richard Weber, president of the Society of Financial Service Professionals, said although producers can still function with only an insurance license, many might consider getting at least a Series 6 securities license to be able to advise clients about their full financial picture. He pointed out an irony that states are adopting an NAIC model for annuity sales that requires asking about investments even though federal law would prohibit insurance-only producers from asking about them. Getting a securities license seems to be “the path of least resistance,” Weber said, adding that adopting a high ethical standard is the best path to staying out of trouble.
“Everything you do has to be as a result of sufficient information following all the suitability standards that you can defend as being in the client’s interest above your own,” said Weber, who, as president of The Ethical Edge, often serves as an expert witness. “That’s the key, holding your client’s interest above your own.”
That is one way to inoculate against the twists that might come from various legislators and regulators. But, still, Kerzner put it bluntly in his annual address: “In the end, government regulation may be the wild card in whether or not we fall into the abyss.”
Even if Obama and legislators manage a deal to avert the fiscal cliff by the end of the year, tax reform is on the agenda for 2013 -- literally. The House of Representatives in August passed HR 6169, which requires the Ways and Means Committee to offer a tax reform bill by April 30, 2013.
Since the election, House Republicans have said that raising revenue should be part of the budget discussion, but Speaker John Boehner added that revenue does not mean tax rate increases. That leaves closing loopholes and eliminating “tax expenditures,” which puts the tax treatment of insurance on the table.
The basis for many discussions is the Bowles-Simpson report, the document produced by a bipartisan committee that investigated tax and revenue issues at President Barack Obama’s behest. The committee came up with a list of tax expenditures, or items that are not taxed and considered a government expense.
The inside build-up of investment income in permanent insurance and possibly annuities is on the list. Others are concerned about the tax-free death benefit and the treatment of insurance in a taxable estate.
Even if all of those escape the tax net, another maneuver might have consequences for insurance. If Congress imposes a dollar value cap on deductions, would that put insurance in a competition for tax-protected status on an individual basis? That was a question posed by the National Association of Insurance and Financial Advisors (NAIFA) in a notice about a fly-in that the association is planning for April 8-9 in Washington, D.C. Other associations are planning to join in what could be called the tax mob.
Here’s a secret: the fiscal cliff is more of a slope. Things don’t start plummeting on Jan. 1 if no deal is reached. The effects would phase in over the year, slowly in the first two quarters and hard in the third and fourth.
But there have been many reports of high-net-worth people moving money around, removing it from places likely to get slammed by taxes. For example, the top capital gains tax rate would rise from 15 percent up to 20 percent, but perhaps more importantly, dividend income would no longer be taxed at the capital gains rate. It would revert to the regular income tax rate, which would top out at 39.6 percent. That is in addition to the Affordable Care Act’s Medicare tax of 3.8 percent on net investment income starting in 2013.
So, advisors can expect that their clients who hold an abundance of dividend stocks will likely have quite a bit of cash on hand, if they don’t already.
The estate tax cliff is perhaps more cliff-like. If no deal is reached, estates valued at $1 million will be taxed at 55 percent starting Jan. 1. This is a dramatic change from the $5.12 million exemption and 35 percent tax rate of this year.
If the estate tax law elapses, it will hit 12.5 percent of America’s families, up from 2 percent, according to LIMRA. Many farming families would likely have to liquidate. Even families with a house in regions with high property values would be scrambling to pay an enormous tax bill on property they would have to sell quickly in a still-challenging real estate market.
Many advisors are seeing this as not only an opportunity, but a duty to inform and protect client families.
Obviously, the independent distribution channel is suffering an aging-out of producers. But the graying of America is good for insurance in many other ways. The bulk of baby boomers continue to crowd into the industry’s sweet spot.
“With 10,000 boomers turning 65 each day, and the total number of retirees growing to 65 million by 2025, there is a real need for accumulation and de- accumulation products,” Kerzner said.
He pointed to moderately rising sales for single premium immediate annuities (SPIAs) as evidence of interest in trading control of retirement funds in exchange for security of lifetime income. But he also looked to the generations behind the boomers as important prospects.
“Generations X and Y are reaching the point where they will be great prospects for life insurance,” Kerzner said. “And 56 percent of Gen Xers believe they need more life insurance.”
All of these issues have opportunities embedded within them. Many of the most successful producers say this is the time when insurance can offer the best value to Americans. In anxious times, insurance is the anchor.
Kerzner and others say that companies cannot sustain the guarantees that have been propelling sales. But the promise of a secure retirement is becoming more attractive. SPIA sales were up 7 percent last year, a blazing performance compared to other products. Whole life has come back in style in financial planning like a Red Wing work boot on a trendy downtown street. The boots were always being made, it just took people to recognize the fidelity that they represent. People will return to the promise that insurance provides in an era where nothing is sure.
A Pew Research poll released in October showed how unsure people are. Four in 10 Americans do not believe they will have enough money to retire, according to its survey. That is up significantly in just a few years. In 2009, that number was one in four. It is even worse for younger people – more than half ages 36 to 40 don’t think they can finance retirement. For good reason, too. Pew says that net worth dropped by half for the 35-44 age group since 2001.
The future is in the network. That doesn’t mean just in people’s social or technology connections, but all of it. Opportunity comes to those who are most active in branching out, relying on others and being accessible. But, of course, the opposite of opportunity is challenge.
Ian Lundahl, a senior analyst at Corporate Insight, said companies are finding their way on social media, particularly in setting up and maintaining relationships with clients while everybody watches. And everybody is watching, which Progressive learned this year when a case went viral.
The brother of an accident victim posted his complaint that Progressive had defended the driver in court against their own client. Progressive had an explanation but was slow to respond and when it did, it sounded like the enormous, bureaucratically bound insurance company that it is. This further inflamed opinion against the carrier until it had to settle with the family and apologize.
The hard-earned lesson points out the challenge for companies and producers in 2013 and beyond. Businesses have to embrace social media to stay relevant. But they can’t go in with a business-as-usual attitude. “We have some clients focusing on social media and e-marketing strategies and even conducting service simulation damage control internally,” Lundahl said. “And they are opening the right lines of communication open between corporate and the individual agencies.”
Partnerships and cross-selling are becoming even more key. Liberty Mutual, for example, has been reaching out to life insurance companies to refer business to one another, a partnership that might have at one time seemed a little like cats and dogs getting along. But they are making it work.
MetLife is going where the people are – WalMart – to sell life insurance. Health insurance companies are setting up kiosks in malls to attract clients. In a post- Affordable Care Act world, health carriers have to rethink business. So are health insurance producers, with many looking to employee benefits and other ways to become advisors.
All the warnings are correct -- the world we live in is coming to an end. But a new one awaits. Whether it is a better one is up to us.
“The good news is, many of the bad things generally don’t happen and there is opportunity to be found in every market,” Kerzner said. “While we may be on the edge of the precipice, what we do now can alter the outcome.”
Steven A. Morelli is editor-in-chief for InsuranceNewsNet. He has more than 30 years of experience as a reporter and editor for newspapers, magazines and insurance periodicals. He was also vice president of communications for an insurance agents’ association. Steve can be reached at firstname.lastname@example.org.
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