Are recent changes to variable annuities making them harder to sell?

Insurers who kicked off the new decade with scaled-back variable annuities focused on principal protection and insured retirement income should stick with that approach, no matter how much the market improves, according to a report by Cerulli Associates analyst Lisa Plotnick in Boston.

She said she expects “a new era of stabilization and rationalization.”

In short, insurers simply can’t afford to slip back into bad habits, aggressively pricing each other out of the market with increasingly elaborate riders, a strategy that failed them. “We expect them to do that,” she said. “This report is to get them to rethink that.”

The main issue with the arms race is that it didn’t bring much in the way of new assets into variable annuities, Plotnick said.

While she doesn’t have figures for all of last year, the first three quarters indicated $14.1 billion of net variable annuity sales. For all of 2008, that total was $23.1 billion. But five years ago, net sales totaled $40 billion. 

“Instead, many policyholders hopped around from one provider to another, she said. "While there’s nothing wrong with that if they’re getting better benefits, there is a tradeoff.”

Comprehensive living benefits don’t seem to slow 1035 exchanges. Plotnick’s report indicated that “most comprehensive provisions are not necessarily the most effective in generating assets,” either, and there is no significant difference in sales between annuities offering a 5% and 6% withdrawal rate, she said.

In order to maintain the long-term stability needed to back annuities’ promises, insurers should generally stick to four to six products and fewer than 80 subaccounts, or investment fund options within a variable annuity.

“You can’t have everyone putting all their money into technology,” she said. “There’s no way to hedge for that level of risk.”

The problem is that without much new money coming in, insurers are at risk of getting hit doubly hard by all the money being withdrawn as baby-boomer policyholders reach retirement.

“Insurers are faced with the challenge of replenishing those assets,” she said.

Instead, insurers need to focus on a decidedly unsexy marketing proposition, which is necessary for the health of an industry that doesn’t yet have the data it needs to manage for guaranteed lifetime withdrawal risk. If baby-boomer withdrawals are going to take a chunk out of insurers’ assets, consider those policyholders who wait a few years longer into their retirement and then start pulling out the larger amounts they’re entitled to.

To build and price new products, insurers have to look at risk in a more averse manner than they have in the past, when averages ruled the day, she said. Now, insurers will have to run many more models and “run to the tail,” which basically means figuring out the least likely, most expensive risk and pricing that into the product.

What this means is more back-to-basics variable annuities that cost a lot more than they used to.

“You can’t go back to what something would cost five years ago, when the climate was very different,” Plotnick said. Rather, advisors have focus not on flashy promises of higher returns, but on financial stability.

For their part, insurers must furnish their wholesalers with persuasive reasons why a scaled back product can compete with a riskier but more flamboyant product offered by a competitor. The basic pitch, Plotnick said, is that “VAs can no longer be seen as tax-advantaged investment products, but instead position them as products that guarantee income in retirement. Product one-upmanship won’t get the industry where it needs to go.”