1Q VA Sales Took A Bad Bounce

Later that month AIG SunAmerica announced an agreement with Ibbotson Associates Advisors, LLC to offer four new fund-of-funds options. The new Seasons family of VAs touts the advantages of retail investors' access to institutional investment management techniques and notes a recent study by Watson Wyatt Worldwide that over the period from 1995 to 2001, the investment results of the largest pension plans outpaced those of 401(k) participants by 1% per year, a significant long-term difference when compounded. While institutionally managed portfolios are also not new to VAs, the recasting in the lifestyle portfolios arrangement is an outgrowth with great appeal to aging boomers concerned with 'targeting' retirement income.

As noted above, not since the introduction of the bonus product has a VA feature held such far-reaching implications and engendered such passionate discussion as the GMWB and its newest cousin, the GMWB for life. At the recent LIMRA/LOMA/SOA Retirement Conference, the subject of GMWBs for life and their forecasted impact on near-term insurer product development was noted by many as the main topic of discussion. One leading independent actuarial consultant who spoke at the event said, "I don't think an Immediate Variable Annuity will be on my project list for quite some time at this point. I see the market moving in the direction of the GMWB for life, and I think that IVAs are really going to have a hard time for a while, even IVAs that have floors on them. They just don't have the momentum."

Not only do many expect this newest living benefit feature to impact IVAs, many expect that it also will have a significant impact on fixed annuitization. The "No Need to Annuitize" statements in current sales literature has some in the industry concerned with that message.

With five issuers sporting the feature and a number of others in the pipeline, GMWBs for life are seen by a growing number within the industry as an easy way to interest customers in a stream of income that is guaranteed for life, without the loss of asset control cited by advisors and their clients as the primary reason lifetime annuitization has failed to appeal to a broader market.

Variations to attract new sales are expected to grow throughout 2005 as this newest living benefit is likely to become the primary VA product sales driver. Some of the variations will include rising benefit bases (already seen in the newest Prudential version) and special contingency options that will enable increases in the withdrawal percentages pursuant to disability or nursing home internment. Advisors and their broker-dealer home offices will once again be pressed to create score cards to keep up with the newest GMWB for life product versions and their suitability to individual client circumstances.

As B-D home office compliance officers integrate this newest version of the GMWB into their client suitability guidelines and back office operations, a more complete picture of the benefit's usage and impact on the retirement income marketplace will develop. Generally speaking, many feel that when you get beyond the ages of 70-75, a comparison to a pure income annuity is warranted. This is especially true for IVAs that include a floor. Taxation issues also become especially important when looking at non-qualified investment capital. GMWB for life withdrawals are taxed gain-first, so a substantial portion of the benefit may be lost to taxes. Close attention must be paid and disclosed to clients who might choose to utilize the feature in favor of variable annuitization with a floor. A thorough after-tax comparison is essential.

Despite growing interest and enthusiasm for the GMWB for life, issues remain–some of which could hold long-term implications for the insurance industry. In addition to increasing demands upon broker-dealers to monitor client suitability, there is a diversity of opinion surrounding the financial implications of the feature should it become a widely utilized replacement for true lifetime annuitization. For example, while many in the industry are concerned about the non-diversifiable risk with regard to reserving and capital requirements, others are not.

As noted, while some industry observers question how VA issuers will cope with the increased reserving and capital requirements should "millions" of contract holders in the future elect the newest GMWB benefit, one prominent independent actuary stated, "I'm not as concerned, quite frankly, because most of these benefits have asset allocation requirements. The thing that is really going to play into the reserving and the capital requirements is going to be the new C3, Phase II regulations that are coming out,most likely at the end of the year. Under this new guideline, a company has to take any benefit that has a guarantee and model it under stochastic trials. Companies are required to reflect in-force business as well as new business and, to the extent that you have business that is out of the money and not really generating any costs, you are allowed to offset against benefits that are in the money. As long as companies continue to maintain fund account asset allocation requirements, then I don't think that the reserve hit is going to be that meaningful, not yet at least. But to the extent that we would have a big bear market, it could be a much different story. I think that the bigger issue is in pricing the benefit. Unlike a pure IVA where customers don't have a lot of options and you know their behavior and there is a predictable stream of income, with the GMWB for life, there are customer behavior elements that weigh in to make the benefit tricky to price. All of these LBs that have customer behavior options create a lot of issues for which we have little historic experience despite all of the modeling which has been done. When the benefit gets into the money, how much more usage will there be, if at all, is a critical unknown. There are no answers; nobody knows for sure. Additionally, we don't know how agents and reps will influence that behavior, which is another unknown factor that could have very significant consequences. In many ways their behavior is an even bigger question."

Others believe that what will come out of the new guidelines (C3, Phase II) could be substantial, especially for firms that have not committed the resources, or do not have the resources to fully model the complex derivative and hedging strategies necessary. Some industry insiders also worry about the potential for arbitrage abuse as time passes and more living benefits get in the money. As one actuary notes, "I'm concerned about institutional behavior. There are a lot of smart people with spreadsheets. It is conceivable that there will be a market where firms will buy VA contracts for more than the cash surrender value now and use the benefits against the insurance company 100%. We've seen this happen with dollar-for-dollar GMDBs. There are firms that market to agents, asking them to go back to their book of business, look for dollar-for-dollar GMDBs, and push the agents to have their clients sell their policies for more than the cash surrender value."

As I look at the VA landscape in the near future, the biggest challenge is bringing new first-time buyers into the VA market, thereby improving net flow and reversing the prevalent declines of the past decade. While current VA owners are satisfied with their products, in the views of many, public perception as noted by one industry leader is "just plain awful." This sentiment is shared by many advisors throughout the country that we have interviewed over the past year.

The National Association for Variable Annuities significantly has stepped up its public relations efforts and engaged industry leaders to tackle many of the internal issues which could ultimately drive enhanced public perception of annuity products. More advisors throughout the country need to be made aware of these efforts.

Lastly, the industry needs to consider the impact of the "No Need to Annuitize" message under which GMWBs are being marketed. Much more needs to be done by the industry to define the benefit utilities of all annuity products and train advisors in their use, as the changing face of retirement moves us all forward.

Rick Carey is managing director-research, of VARDS, a unit of Morningstar, Inc. He can be reached at [email protected].