Insurers likely to sweeten indexed annuities

Higher interest rates are likely to result in insurers’ sweetening their fixed-indexed-annuity offerings this year as they try to catch a wave of renewed investor interest.

Allianz Life Insurance Company of North America, for instance, recently increased the cap rate — the limit on potential returns clients can receive from stock market gains — in its popular MasterDex X fixed index annuity to 4.25%, from 4%. It also increased the cap on other FIA products by 0.25%.

Last year was a mixed blessing for carriers that sell the products, which offer a guaranteed minimum return, as well as a return based on the performance of a stock market index. Customers flocked to indexed annuities, at least in part because of new living-benefit features, generating some $32.1 billion in sales, up 7% from 2009, according to LIMRA. But low interest rates made the business less profitable for carriers.

The low-rate environment forced the largest indexed-annuity sellers — Allianz, American Equity Investment Life Holding Co. and Aviva USA — to begin trimming features last fall.

“Now, yields have come back to where they were at the start of 2010, and we’re having conversations again with carriers about enhanced features,” said Tim Hill, a consulting actuary and principal at Milliman Inc.

Carriers had loaded their investment portfolios with cash following the financial crisis and then gradually shifted funds to highly rated corporate bonds in search of yield. At the beginning of 2010, a seasoned corporate bond rated Aaa by Moody’s Investors Service was yielding 5.34%. But yields on top corporates dropped over the summer, falling to as low as 4.31%. (They rose to 5.26% by mid-month.)

That decline sparked a number of product cutbacks, as low yields constrict what carriers can afford to offer in the way of benefits, Mr. Hill said.

Aviva last year cut premium bonuses on a handful of products and trimmed commissions on its Income Select product by 1%. Allianz Life lowered the cap on returns and reduced bonuses, said Eric Thomes, a senior vice president at the company.

Last month, American Equity lowered the crediting rate, or the interest rate it paid on its fixed-interest strategy for new FIAs, to a range of 2% to 2.1%, from a range of 2.5% to 2.6%, said chief executive Wendy Waugaman

Despite those cuts, consumer demand for the products rose. Insurance executives believe demand was driven to some degree by new living-benefit features. Allianz, for instance, introduced a rider that ties the income received by the investor to the consumer price index. The insurer sold $7.1 billion in FIA annuities last year, reflecting a 19% increase from the previous year, and about half of those sales included an income benefit, Mr. Thomes said.

To deliver yield, insurers now are increasing their exposure to commercial-mortgage-backed securities and other structured securities, private equity and unaffiliated common stock with high dividend yields, according to a recent report from ratings agency A.M. Best Co. Inc.

“Some of them are buying commercial- and residential-mortgage-backed securities for cents on a dollar, hoping there’s no credit risk and that they can maintain the expected returns,” said Andrew Edelsberg, a vice president at A.M. Best.

On average, carriers have about 10% of their assets invested in mortgage-backed securities, he said.

American Equity, which has shifted away from U.S. agency bonds, has been yield shopping in the taxable-municipal-bond area, including Build America Bonds, Ms. Waugaman said.

The insurer also originates commercial mortgages, which Mr. Edelsberg describes as a way to get some indirect exposure to real estate.

“It requires something of a skill set: You need the right people, strict underwriting and distribution to do that,” he said.

In addition to a brighter investment picture, carriers also are benefiting from last year’s defeat of a rule the Securities and Exchange Commission proposed that would have designated FIAs as securities rather than insurance products. This could have alienated independent agents, the chief sellers of FIAs.

The defeat freed carriers from having to prepare their sales agents to obtain securities licenses.

“There’s a lot of clarity now, so companies that weren’t sure what they wanted to do can go into product development assured that FIAs are considered insurance,” said Joe Montminy, assistant vice president for annuity product research at LIMRA.

E-mail Darla Mercado at [email protected].