The problem of annuity persistency seems to be growing, not shrinking. Over the past few years, most insurance carriers have expressed disappointment with annuity lapses that are well in excess of their original pricing models. These surrenders have a huge impact on profitability and ultimately impact the carriers' appetite for new annuity business as well.
Carrier responses have ranged from do-nothing to aggressive conservation and replacement programs. Do-nothing carriers are certainly a shrinking universe. Most companies are at least trying to save large policies that are on their way out. But this is still largely a reactive mode and not terribly productive.
Before I go too much farther, it probably makes sense to define some terms and provide some history.
All deferred annuities (both fixed and variable) are priced with an expected lapse pattern. In other words, there is some expectation that the annuity owners will voluntarily withdraw some or all of their assets over the years. Lapses also happen due to an owners death, but well ignore that here, because it doesnt represent a voluntary withdrawal.
Partial withdrawals are also a form of lapse, but since they typically dont represent huge problems, and typically are taxable, we will ignore those for this discussion as well.
Its worth noting that both deaths and partial withdrawals can represent significant problems for insurers if they are not priced properly, but these problems are typically orders-of-magnitude smaller than total lapses.
By far, the biggest problem insurers face are total withdrawals (also called lapses or surrenders) done via Section 1035 exchanges. A 1035 exchange affords the owner the ability to maintain tax deferral as he moves from one insurer to another. The worst problem usually occurs in the year following the end of the surrender charges. This is known as the shock lapse. The owner feels "free" to move as he wishes or is advised, and agents feel "free" to find a better deal for their clients and often a new commission.
The pricing/profit problem comes from the fact that the actual lapse level is in excess of the expected lapse level. Ive seen recent situations where actual lapses have exceeded expected lapses by 4 or 5 times. This can take an otherwise profitable block of annuity business and turn it into a true disaster. Some carriers have been forced into $10′s of millions or even $100s of millions in write-offs due to this problem over the past few years.
Now that we understand the problem, what can be done about it? Actually quite a bit.
First, insurers need to recognize the problem and commit resources to solving it. Just as there is a team dedicated to new business (sales) there should also be a team dedicated to conservation. This team neednt be large, but it should be dedicated and committed. It should also include at least one member from the top management of the company.
Now Im going to deviate from the conventional wisdom of conservation. The conventional wisdom of conservation tells you to begin your conservation activities either at shock-lapse time or shortly before. I believe conservation starts before you even sell the policy. In fact, it starts with the selection of your distributors and the product you design for that distribution.
Lets start with a look at distribution. There have been a few studies done over the years that have tried to discern lapse pattern differences from among a multitude of distribution systems. My opinion of these studies is that they are inconclusive and possibly misleading.
The studies typically look at a small group of policies, often from only one insurer. Product types as well are segmented only in vague and broad categories. This means that not enough detail is used on product type and not enough companies and distributors are used.
