Pacific Life swims against the tide in the indexed annuity market

Analysts say the insurer is the only one to guarantee its cap rates during the contract surrender period, a boon for investors but potentially opening it up to more risk

Mar 9, 2018 @ 5:08 pm

By Greg Iacurci

Pacific Life Insurance Co. is an outlier among the scores of companies selling indexed annuities.

Of the roughly 60 companies that manufacture these annuities, Pacific Life is unique in that it guarantees the maximum interest rate on its products during the contract term. Other insurers reserve the right to — and often do — lower these rates periodically based on market conditions.

"In the 13 years I've owned my business, Pacific Life is the only insurance company that has guaranteed the caps on their indexed annuities over the life of the contract," said Sheryl Moore, president and CEO of Moore Market Intelligence, a consulting firm.

While observers say this product feature is a competitive advantage in a crowded market, some say it could pose additional risk for the company.

Indexed annuity sales have increased dramatically since the financial crisis, more than doubling over the past decade to just shy of $60 billion. Pacific Life was the 15th largest seller of these products last year through the third quarter, at $942 million, according to market research firm Wink Inc.

Insurers market the products as offering upside potential with no downside risk — they can't credit less than 0% interest over a given period, and growth is linked to the performance of a market index like the S&P 500.

(More: Indexed annuities' performance may not be what you expect)

Insurers use restrictions such as caps to limit upside. A cap of 6%, for example, means even if the stock market goes gangbusters, an investor would get a maximum 6% return.

The vast majority of insurers can contractually lower those caps, to 5% from 6%, for example. Most do change them, especially on policies sold years ago, due to the low interest rate environment, said Jessica Rorar, an investments planner at ValMark Financial Group.

Insurers can change caps as frequently as they credit interest (perhaps annually or every few years). The majority of Pacific Life's indexed annuity products, however, guarantee the cap rates will remain intact.

Those products are: Pacific Index Advisory, Pacific Index Choice, Pacific Index Select (a product proprietary to Wells Fargo distribution) and Pacific Index Foundation, according to Wink Inc. (The firm's Pacific Index Dimensions and Pacific Index Edge products don't carry the guarantee.)

"We see it as a differentiator and a competitive advantage," said Steve Goldberg, assistant vice president of annuity product management at Pacific Life.

(More: DOL fiduciary rule continues to take toll on annuity sales)

Products with the guaranteed cap rates, as well as those without, are available to independent broker-dealers, banks, wirehouse brokerages and some independent insurance agents. The guarantees are in place during the surrender period (the time frame, often 7 to 10 years, in which consumers can't sell their annuity without penalty). The company can reset caps on an annual basis after this period, though.

While some observers see the ability to tout a locked-in interest rate as an advantage for Pacific Life, they also say it can come at the expense of a cap rate that's lower than that of comparable annuities.

"To me that's a fair trade off," said Robert McCommon, director of special products at Wunderlich Securities, Inc. "If you want a higher cap rate, you take the risk that they could lower your cap rate in the future."

Data from Wink Inc. shows that Pacific Life's average guaranteed rates are actually often higher or roughly equal to those of comparable products in the broader industry. Take the Pacific Index Foundation 10 annuity, for example. It currently has an average 5% cap compared with an industry average 3.94%, according to a Wink Inc. analysis. (Wink reviewed S&P 500-linked products crediting interest based on an annual point-to-point method and with the same 10-year surrender period.)

Conversely, the Pacific Index Choice 6 currently has an average 4.9% cap, lower than the 5% average for the broader industry.

Ms. Rorar and other observers said the guaranteed caps could be a riskier approach for Pacific Life, although company executives expressed confidence that the company's investment portfolio could support them.

(More: Complexity of new indexed annuities causing concern)

Timothy Pfeifer, an independent actuarial consultant in the Chicago area, said a concern around guaranteed cap rates lies with interest-rate risk. If interest rates were to drop "precipitously," insurers may not be able to afford the guaranteed rate if they had to invest at lower-than-forecasted rates, he said

Interest-rate risk is likely a secondary concern for the majority of insurers, though, said Mr. Pfeifer. He said most insurers likely don't offer guaranteed caps primarily because of concerns over reserve levels. More generous guarantees require more reserving to cover the guarantees, which penalizes insurers from a company income perspective, he said.

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