The long-suffering variable annuity market is going to get worse before it gets better, a product expert with Morningstar said last week.
From new regulations issued by the DOL to investment restrictions in subaccounts to stingier guarantees, variable annuity sales are not expected to pick up anytime soon – though no one is predicting the death of the variable annuity market.
Variable annuity sales volume of $100 billion won’t simply disappear overnight, but new sales have been thinning faster than the polar ice cap.
“There’s a void right now,” in variable annuity sales, said Kevin Loffredi, senior product manager for Morningstar in Chicago.
New sales of variable annuities fell 20 percent to $23.96 billion in the fourth quarter from the year-ago period as sellers hit the brakes in the face of new regulation, confused distributors and waning attention paid by insurers, Morningstar reported.
New sales of variable annuities fell 21.4 percent to $101 billion in 2016 compared to 2015, the mutual fund tracker reported.
For the fourth year in a row, variable annuity assets under management have held steady at about $1.8 trillion, Morningstar reported.
The DOL fiduciary rule, which raises investment advice standards into retirement accounts, has many sales reps looking over their shoulders talking to lawyers about advisors’ potential future liability and “best interest” advice thresholds, he said.
There is a sense among broker-dealers and within the home offices of insurance companies that variable annuities are adrift.
“Annuities are sold and not bought, that’s true, but they need to be nurtured at the broker-dealer and if the home office isn't encouraging reps to nurture them and tell people how to use them, then interest in the product will wane,” Loffredi said.
And wane they have, from $141.2 billion in 2013 to $135.9 in 2014 to $128.1 in 2015 to $101 billion in 2016, according to Morningstar data.
In the past, the entirety of a $600,000 rollover might have ended up in the variable annuity.
With the DOL’s best interest threshold, the variable annuity might now only receive $400,000 with the remainder rolled into another type of investment -- an ETF, for example.
FINRA regulators, who last year levied a record fine against MetLife in connection with variable annuity sales, have identified variable annuities for heightened supervision on account of their costs and complexity.
“As for the DOL rule, in my view, it caused variable annuity product development activity to slow of late, especially during the period when the rule was in draft form,” said Steven D. McDonnell, president of Soleares Research.
“Now at least insurers know what they will have to work with,” McDonnell added.
But the fact remains that the variable annuity market was shrinking long before the DOL proposed its restrictive fiduciary rule last year so regulation isn’t entirely to blame for the rapidly shrinking market.
Variable annuities remain under pressure from the yield on the 10-year Treasury note, which is a gauge of how rich a benefit variable annuities can provide to investors.
Low Treasury yields force insurers to pull back on the benefits. Higher yields offer insurers opportunities to be more generous.
With the yield on the 10-year Treasury note still depressed by historical standards, insurers are limited by what and what they can hedge and set aside in reserve, Loffredi said.
Insurers don’t want to get caught by a severe market downturn, as they did nearly 10 years ago when financial markets collapsed.
When interest rates subsequently plummeted, insurers suddenly found themselves obliged to continue paying generous variable annuity benefits.
Meanwhile, new money invested into fixed income portfolios were generating lower returns.
This time around, insurers have raised the costs of benefits and the lifetime guarantees on their variable annuities.
Benefits have not only been priced in the range of 300 to 400 basis points, but insurers are limiting the investment freedom advisors have with subaccounts, Loffredi said.
Insurers have eased up on some of their variable annuity control levers as the financial crisis recedes further.
But lowering fees and the loosening investment restrictions don’t appear to be among them since insurers remain on the hook for the guarantees, Loffredi said.
“Fees are still expensive and the investments still require stricter guardrails so the insurance company is limiting its equity exposures,” he said.
In a bull market, when investors see their 401(k) accounts growing steadily, the managed volatility funds within the variable annuity deliver muted returns by comparison.
Reps are dealing with phone calls from clients who do not necessarily grasp that their investments are in managed volatility subaccounts, he said.
Clients point to their galloping 401(k)s and scoff at the tepid growth of funds in variable annuity subaccounts, which makes it hard for advisors to sell the variable annuity contracts, Loffredi said.
In bear markets, which managed volatility strategies are designed to hedge against, investors rarely credit volatility management for muted losses since investors are guaranteed a return by the insurer.
Fixed Side Competition
There’s no question that variable annuities have being made to look uglier over the past few years — a lot of it by design — and it should come as a surprise that buyers, unimpressed by what they’ve seen, have turned away.
Where have they turned?
Many have sought refuge among fixed annuities, in particular fixed indexed annuities, which soared 12 percent to a record $61 billion in sales in 2016 compared with 2015, industry data show.
As recently as a few years ago, variable annuity market share approached 70 percent of all annuity sales.
But 2016 is the “the first time in a long time” that variable annuities have dropped below 50 percent in annuity market share, said Todd Giesing, assistant research director for industry tracker LIMRA Secure Retirement Institute in Windsor, Conn.
Last year, fixed annuity sales rose 14 percent to a record $117.4 billion while sales of their variable annuity cousins came in at $104.7 billion, LIMRA reported earlier this year.
Indeed, quoting activity for income annuities — single premium immediate annuities and deferred income annuities — reached a record in the December 2016-February 2017 time period, said Gary Baker, president of Cannex USA.
In the previous three years — February 2014, 2015 and 2016 — advisor quote activity increased on average by 18 percent compared with the previous December, but this year quoting activity rose 28 percent, he said.
Industry analysts estimate there’s about $220 billion at stake up for grabs in the entire annuity market.
Morningstar's variable annuity data does not include sales from CUNA and Voya Financial and reports new sales only.
Total sales includes internal transfers within an insurer. Under a "total sales" measure, Morningstar would have reported $102.2 billion in variable annuity sales in 2016.
A Bounce Back?
The heights to which the variable annuity market once soared appear to have vanished, at least in the short and medium terms, but any talk about the disappearance of the variable annuity market would be premature.
“In order for the variable annuity industry to rebound, insurers will have to devise products that do not rely on risky guarantees, but will somehow still resonate with advisors and their clients,” McDonnell said.
“This will take time, creativity and innovation.”
Insurers indicate they are prepared to innovate with many coming out with fee-based variable annuity annuities to entice more financial advisors.
Rising interest rates also help all annuity sales.
Remember, too, that insures have been “managing down” variable annuity sales as they reduced their risk exposures.
Leaving fees and investment restrictions aside, some variable annuities offer rollup rates of 6 to 7 percent so there are still a lot of rich benefits to be gleaned from a variable annuity if you know where to look, Loffredi said.
Some insurers — Jackson National, the top variable annuity seller in the country last year with $17.2 billion in sales, for example — offer variable annuities with little or no investment restrictions so it pays for advisors to shop around.
Demand for guaranteed income, however, continues to rise as large swaths of baby boomers and millions of Americans belonging to generations born after 1964 find themselves underprepared for retirement, according to many nationwide surveys.
Would the rebound into the variable annuity market turn into a stampede? No, said Loffredi. Would the sales slide level off and would sales improve once again? Yes, most likely, he said.
“My opinion is that variable annuity usage would level off or increase slightly but not a flood going back in,” Loffredi said.