Toward the end of January, the
Raymond James fixed and indexed annuity team met with one of our insurance partners to discuss possible future product designs and the indexed annuity market overall. I opined at the time that it would not surprise me if by the end of the year,
Raymond James experienced a month when indexed annuity sales exceeded those of variable annuities.
For some years now,
Raymond James has witnessed steadily increasing sales of indexed annuities while sales of variable annuities have been relatively flat. Back in December 2012, a small percentage of all annuity sales went to indexed products; by December 2015 it was significantly more, and in January the percentage jumped. Obviously, one month does not a trend make, but I think it's safe to say that the annuity industry is in the midst of a fundamental change.
So how did we get here? Historically, variable annuity sales tended to rise and fall with the fortunes of the stock market. In other words, when the market does well and equities are in vogue, variable annuity sales increase and vice versa. Clearly, the markets have been rocky at best since August, with volatility accelerating into the new year, and no doubt this contributed to the drop in variable annuity sales we saw in January. However, this relationship has weakened over the last several years, suggesting other factors are influencing the shift toward indexed annuities.
CONSUMER-FRIENDLY
Let's start with the indexed annuity market and look at why industry sales grew from an estimated $33.9 billion in 2012, according to LIMRA's Retirement Income Reference Book, to what will likely exceed $50 billion, and possibly $55 billion, when the final estimates are in for 2015. Much of this increase can be attributed to the fact that product designs have become much more consumer-friendly.
While 15-year-plus surrender charge periods and 10%-plus commission schedules can still be found, they are now the exception. The sweet spot in consumer pricing is with surrender charges of seven to eight years — a time period that likely would be reduced further if we saw a material increase in interest rates. At Raymond James, the average upfront commission on an indexed annuity is 4.1%. The fact of the matter is any product with a significantly higher commission simply can't offer competitive rates.
Without a doubt, the entry into the marketplace of some of the more traditional annuity carriers has given the product line credibility and marketing support. In recent years, Nationwide Financial, American International Group, Lincoln Financial and Pacific Life have introduced indexed annuities. This, of course, has changed their wholesalers from product critics to product promoters. Given recent sales trends, it is just a matter of time until other leading annuity companies enter or re-enter the market.
FOSTERED BY DECISIONS
It's my opinion that indexed annuity sales have also been fostered by decisions made over the last five years by variable annuity companies, decisions that led to the disconnect between variable annuity sales and equity market performance seen since 2011. To begin with, variable annuity companies shifted their story away from positioning their products as tax-deferred alternatives to mutual funds and homed in on the lifetime income protection provided by the living benefits. I'm not criticizing the value of these benefits. However, when the entire story is focused on which product has the highest roll-up rate or the most frequent step-ups, the equity story tends to get lost.
In addition, to protect those benefits and limit the potential risk to the insurer, companies began to dilute investment options to the point that account appreciation after fees was difficult to achieve. Only Jackson National continued to allow investment flexibility. In short, by requiring a heavy fixed income allocation and/or overlaying a volatility-controlled investment discipline, the variable annuity companies effectively turned their products into an indexed annuity within a variable annuity chassis. If you essentially turn your product into an indexed annuity with the primary marketing message focusing on the amount of guaranteed income, you will lose the sale when the adviser compares your guaranteed income to that of an indexed annuity.
Unfortunately, many variable annuity companies changed more than just the available investment options. Many chose to further reduce their risk by placing limits on existing and new policies. Advisers found themselves in the uncomfortable position of having to explain to clients why they could no longer add to their existing policy or invest in a particular subaccount. In addition, a handful of carriers further exacerbated the situation by continually offering buyout options to their clients.
MARKET ENVIRONMENT
I completely understand why variable annuity companies made these decisions: The market environment no longer supported the original assumptions on which these products were based. Post-financial crisis, the low-interest-rate environment proved these assumptions to be unsound, and product changes were inevitable. Still, the industry would have been naïve to think these changes would not have an impact on future sales.
I think there is still more going on here. I believe we are in the midst of a demographic shift that is tilting in favor of indexed annuities versus variable annuities. Not surprisingly, as baby boomers age, they are choosing more conservative investment options. After experiencing both the bursting of the tech bubble and the great
recession in the same decade, many boomers have concluded they cannot take the chance of another tail-risk event.
All of a sudden, indexed annuities that guarantee never to credit less than 0% (prior to any rider fees) and offer a likely 3% to 4% average annual return seem like a good option. And if the indexed annuity provides the highest possible level of guaranteed future income without forfeiting the investor's desired liquidity, it will remain an attractive option for many investors given today's market environment.
VARIABLE ANNUITIES
Variable annuities still serve a purpose in this market and are appealing investments for those wanting a tax-deferred multi-asset class portfolio with a guarantee upon death. The fundamental story behind these products holds true, and variable annuities have found themselves right back in the place they were before the world ever heard of a living benefit.
Scott Stolz is senior vice president of Private Client Group Investment Products at Raymond James Financial Inc.
