Comments on the March 23 Money Management Executive Article on the VA Industry by Garth Bernard

An article appeared recently in Money Management Executive that we just had to respond to (March 23, 2009; Vol. 17, No. 12 – Variable Annuity Prices Up, Despite Sales Drop, by Matt Ackerman, American Banker)

“It’s counterintuitive – wealth managers are ratcheting up the price and providing lower returns on variable annuities.” We think while Ackerman states the fact, he may be forced to say, tongue-in-cheek, that it is “counterintuitive” because there are suggestions by some experts quoted in the article that the price increases and reduced benefits on the popular guaranteed lifetime withdrawal benefit (GLWB) riders are no big deal and will likely not significantly impact variable annuity sales.

At RISE, we don’t think this is just another ho-hum day in variable annuity land. We’d like to go on record as saying quite the opposite … this will have a major negative effect on variable annuity sales!

The costs of hedging the GLWB has sky-rocketed and current fees can’t cover the cost of the benefit. That’s why raising prices on a benefit already perceived as expensive is absolutely necessary. But one would have thought the variable annuity industry would have seen this coming had the possibility of a severe downside scenario been considered. There were prior warnings too that the benefits may have been underpriced.

However, the hopelessly optimistic conjecture that sales will not be impacted is simply not based in reality. The reality is that variable annuity sales, which fell approx. 15% in 2008, were already challenged by a combination of factors including:
• The decline in equity market returns … despite the availability of guarantees, variable annuity sales have historically always declined in tandem with equity market declines though less so than mutual fund sales;
• A lack of widespread acceptance of variable annuities among advisors and consumers due to the perception that these products have high fees and that the features are overly complex. 

But now, there are several additional factors that will also weigh heavily against a sales increase in 2009:
• Equity market declines have gotten worse in 2009 driven by the recession which started arguably in late 2007 and are not expected to show robust positive performance anytime soon;
• The real and perceived financial strength of the insurance manufacturers who have dominated the variable annuity market has been diminished by outsized financial losses and financial ratings downgrades. Since the value of any guarantee is only as good as the guarantor, any degree of lost confidence in the ability of the variable annuity industry to deliver on its guarantees will adversely impact sales;
• It is likely that the upward re-pricing of GLWB benefits will continue in 2009 since initial adjustments may not have been sufficient across the industry;
• Investor psychology may be that the market is at or near bottom and the demand for down-side protection at a potentially substantial cost to upside, given the new higher GLWB fees, may be severely diminished … the GLWB simply begins to look and feel like a fixed annuity, but with a prospectus.

The clear and present conclusion in view of these factors is that the variable annuity industry has suffered a damaging blow which, combined with the current and expected future market conditions, is likely to lead to a significant ongoing decline in variable annuity sales in the absence of a strategic shift in the thinking and in the actions pursued by variable annuity manufacturers.

In our view, what’s needed is a complete re-design of the GLWB benefit from the ground up that would result in lower GLWB fees, reduced risk to the carriers and thus lower hedging costs. Now that’s what we call counter-intuitive!