The annuity industry must develop fundamentally new products and distribution strategies to counter dwindling profits in a saturated market, says a new report from Cerulli Associates.

In today’s arena, 65 companies compete with more than 450 different annuity contracts, according to "The State of the Annuity Industry" report. In 1986, 25 companies offered 45 products.

Moreover, the top 25 money managers control 77% of variable annuity assets, while the remaining 192 managers fight for the scraps.

Cerulli analyst Cynthia Saccocia, who wrote the study, said insurers will continue to develop new annuity products that will keep the investors’ assets throughout all life stages: accumulation, protection, distribution and transfer of wealth.

Insurance companies already have begun responding to the demands of its distributors by designing "low-load" annuities for fee-based planning services. In "low-load" contracts, the initial commission is smaller (4% to 5%) than traditional contracts (6% to 7%), but low-loads pay a trail commission -- 90 to 100 basis points -- when the surrender-charge period ends, typically three or fours years, as opposed to seven years in traditional contracts.

Saccocia said time would determine whether this product would survive in the marketplace. She said insurance companies don’t make a profit in low-load contracts until the trail fee begins, typically around the fifth year. Distributors, she said, haven’t given any assurances that they won’t move the assets into other low-load contracts as the surrender-charge period draws near. "There are no real guarantees the assets will stay on the books," she said.

Besides new products, more insurers must create retention programs to keep annuity assets, Saccocia said. Cerulli estimates that less than 3% of an insurer’s book will annuitize. In fact, 50% to 80% of a book older than five years will be exchanged to another carrier or surrendered for another product.

In response, more insurers are offering an "persistency bonus" annuity, where they pay current annuity holders about 2% to 3% of their current contract value to upgrade to a new contract with a new surrender-charge period. Saccocia said an example of an upgraded benefit could be a higher death benefit for a similar mortality-expense charge.

Also, insurers must strengthen their relationships with broker-dealers to survive. The largest broker-dealers have dropped 50% to 60% of their vendors because wholesale management has become too costly to manage, Saccocia said. After all, the BD channel is crucial, considering that top insurers can attract as much as 80% of a firm’s total annuity sales. In the second quarter of this year, captive agents accounted for 37% of variable annuity sales, compared to 55% in 1995 -- a statistic that underscores insurers’ reliance on the channel.

Cerulli expects the BD channel to become more important as baby boomers begin to retire. About 20% of the United State’s population could be retirement age when the last boomer turns 65. The Boston-based consulting firm estimates that the BD channel will capture 40% of annual IRA rollover contributions. Cerulli believes IRA assets in annuities will grow to $690 billion in 2010.

To read more about Cerulli’s reports:

No Longer Institutional: Cerulli finds that separate accounts increasingly are an offering by brokers and advisers to individual clients.

A Fading Bloom: The independent broker market is no longer a rose garden, Cerulli says.

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