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Age Of The Annuity

Forgive fixed annuities if they do a little victory dance. They won the brutal marathon of 2008 while many standby insurance products stumbled along with the rest of the financial market.

Fixed annuities sprinted to a $107 billion finish, up 60 percent from 2007. As the economy slumps into 2009, so grows the momentum for another good annuities year.

But hold your cheers if you are an independent producer, because you are getting pushed back in the annuities crowd, elbowed out by captives and banks.

Even though independent producers remained the most important channel for annuities sales, their share dropped to 38 percent of the market in 2008, down from 50 percent. One of the key surprising findings from the Beacon Research 2008 Fixed Annuity Premium Study is that independent producers had a great sales year but might not have even noticed that the market shifted underneath them.

First, we'll take a look at what happened in 2008, then we'll see how independent producers ended up with a shrinking piece of the market.

Conditions Ripen for Maximum Annuities Performance
As 2008 began, the economy struggled with fallout from the subprime mortgage debacle, along with inflationary pressures from rising commodities prices and the declining dollar. These problems intensified over the year until all hell broke loose in September, when one major financial institution after another failed, credit markets froze and the federal government scrambled to stave off disaster.

Dominoes fell across the economy for the rest of the year, until the S&P 500 ended almost 38 percent lower than it was at the beginning of 2008. The flight to safety took off in 2008 but it hit the stratosphere on Sept. 17, when the three-month Treasury bill yield turned negative.

Conservative investments such as fixed annuities became more attractive. Credited rates at the important 5 percent threshold level were available throughout 2008. Thanks to a positive yield curve and a widening spread between Treasuries and corporate bonds, fixed annuities also had a competitive rate advantage over bank certificates of deposit (CDs) and other conservative alternatives. The first quarter's estimated sales of $19.6 billion were up from the prior quarter, and things really took off from there, with sales rising in each consecutive quarter to set successive six-year records. The year ended with estimated fourth-quarter sales of $34.1 billion, 90 percent higher than a year earlier. As fixed annuities took off, variable-annuity sales were falling, and, by fourth quarter, fixed annuities outsold VAs.

Fixed Annuities Break Out of the Pack
In dollar terms, fixed-annuity sales increased $40.1 billion in 2008. More than two-thirds of this gain came from growth in fixed-rate annuities without market value adjustments (MVAs). Estimated non-MVA sales were $53.7 billion in 2008, up 103 percent after four consecutive years of decline. When fixed annuities have a rate advantage over other conservative interest-bearing alternatives, the impact is usually greatest on banks, due to direct competition with CDs. This affects non-MVA fixed-rate sales the most, because banks sell the majority of these annuities (60 percent in 2008). All the other distribution channels had double- and triple-digit increases as well. This growth pushed the non- MVA share of overall fixed-annuity sales to 50 percent from 40 percent, making fixed annuities 2008's dominant product type.

Sales of fixed-rate annuities with MVAs were responsible for 23 percent of the overall year-on-year increase. MVA results were an estimated $17.7 billion, 112 percent ahead of 2007 for the same reasons – a flight to safety coupled with competitive rate advantage. The $9.3 billion gain boosted MVAs' share of total fixed-annuity sales to 17 percent from 13 percent. Sales showed double- to triple-digit MVA increases in all channels. Broker/ dealers (B/Ds) generated 44 percent of the gain and independent producers 30 percent.

Single premium immediate annuity (SPIA) sales climbed 30 percent to an estimated $8.6 billion in 2008 and accounted for 5 percent of the overall increase. Payouts were better in 2008 than 2007 because the yield curve remained positive. These products also benefited from increased promotion. But the main factor fueling results was probably baby boomers' growing demand for income replacement. The falling value of their investments probably made a reliable monthly check look particularly attractive in 2008. But since SPIA sales were ahead less than fixed-rate annuities in dollar terms, their share of overall sales actually dropped slightly – to 8 percent, from 10 percent in 2007. All channels except wirehouses saw double-digit percentage increases in SPIA sales. But most of the growth was generated by the two most important immediate annuity channels: Captive agents accounted for 39 percent of the gain and independent producers 34 percent. Growth may have been somewhat less among independent producers due to their focus on indexed annuities' guaranteed lifetime withdrawal benefits (GLWBs).

Indexed annuities were ahead less than the other product types in dollar and percentage terms, rising 6 percent to an estimated $26.7 billion and contributing 4 percent of the overall gain. As a result, the indexed share of total 2008 sales fell to 25 percent from 38 percent. But the results are actually impressive, given the troubled equities market and negative publicity related to this product type. The prospect of Securities and Exchange Commission regulation may actually have helped sales if it inspired a sellthem- while-you-can attitude among marketing organizations and insurance agents who don't sell securities. By the fourth quarter, many products were offering attractive fixed rates and premium bonuses. The products also saw a promotional push on downside protection features, including return of premium, high minimum guaranteed rates, and especially heavily marketed GLWBs featuring income account premium bonuses and step-ups. But GLWBs weren't enough to increase variable annuity sales. In the final analysis, indexed sales were ahead of the prior period probably because buyers expected future equities prices to rise enough that their credited rates would exceed those of fixed-rate annuities. Upside potential must have looked especially promising, given stock market conditions. With two minor exceptions, participants' 2008 indexed sales were up in all channels. But it was independent producers who generated more than two-thirds of the $1.5 billion gain.

The divergent results of variable and indexed annuities strongly suggest that annuity owners care about account values, GLWBs or no GLWBs. The results of indexed versus fixed-rate deferred annuities suggest the same.

Sales of the top 10 study participants reflect these product trends. In 2008, half derived most of their sales from fixedrate non-MVA annuities, three from a combination of both fixed-rate product types and only two from indexed annuities. (See Chart 1: Top Fixed Annuity Carriers by Product Type, previous page.)

Players Change the Game in 2008 In 2008, year-over-year sales were up in all distribution channels. Banks were 94 percent ahead and generated 33 percent of participants' sales, up from 27 percent. Captive agents' results rose 84 percent, pushing their share to 14 percent from 12 percent. The collective B/D share increased to 12 percent from 8 percent on a 134 percent improvement in sales. Although these channels had growth in all product types, these gains came mainly from deferred fixed-rate products.

Independent producers remained the most important channel overall, but their share fell to 38 percent from 50 percent. Year-to-year growth was 21 percent, the smallest increase of any channel in percentage terms. As was true in the other channels, there were gains in all product types. Indexed and SPIA sales increases were about the same as elsewhere. But percentagewise, there was less independent producer growth in sales of fixed-rate annuities. (See Chart 2: Fixed Annuity Sales by Channel.)

Independent producers were also the most productive channel in 2008 for all product types except non-MVA fixed-rate annuities. They generated 89 percent of participants' indexed annuity sales, about the same as in 2007. The miniscule 0.8 percent B/D share was also unchanged. This is an indication that the vast majority of indexed sales by securities-licensed insurance agents are still going through marketing organizations (even if supervised by their their B/D). In addition, independent producers had a dominant 37 percent share in MVAs and a 35 percent share in SPIAs. Their MVA share dropped significantly from 48 percent in 2007, but their share of SPIA sales was down just 200 basis points. In non-MVAs, their 10 percent share was slightly lower.

To some extent, independent producers shifted their sales focus in 2008. Only the SPIA share of their sales was basically unchanged, at 7 percent. Fixed-rate annuities accounted for 30 percent, up from 21 percent a year earlier. Conversely, indexed annuities generated 63 percent of their sales versus 73 percent in 2007. These shifts strongly suggest that a significant number of these producers' customers preferred a fixed rate to the uncertain upside potential of indexed annuities during the period's troubled equities market conditions. As mentioned above, account values do seem to matter to many annuity buyers despite the presence of lifetime income guarantees.

The year's distribution trends are reflected in 2008's top 10 products by channel. Eight of the best sellers in the independent producer channel were indexed annuities. Fixed-rate non- MVAs were six of the year's top B/D products. For all channels combined, half of the best-selling annuities were fixed-rate non-MVAs. (See Chart 3.)

Place Your Bets for 2009 We think 2009 will be a great year for fixed annuities. The economic environment should resemble that of the fourth quarter of 2008, with dropping equities prices, a continuing move toward conservative investments, minimal inflation and rising consumer saving rates. With these conditions prevailing throughout the year, we expect results will be even better than in 2008.

It is true that fixed-annuity credited rates are falling along with interest rates in general. (For example, the top rate on a five-year MYG/CD-type annuity was 5 percent a year ago in our AnnuityNexus database. As of this writing on March 3, the top rate is 4.9 percent.) But fixed-rate annuities should continue to have a competitive advantage, because the yield curve is likely to remain positive and corporate bonds probably will keep paying significantly more than Treasuries. We expect sales of these annuities to keep growing significantly in 2009.

Now that fourth-quarter results are in, we're convinced that there will be strong growth for immediate annuities. It is true that payouts are down and many people are postponing retirement. But a lot of retirement money is sitting on the sidelines in cash. Guaranteed monthly income looks pretty good compared to trying to live on withdrawals from depleted assets. With minimal inflation and the distinct possibility of deflation, those monthly checks look even better. And it's a lot easier to live on SPIA payouts than interest from CDs and money market funds in today's low-rate environment.

We think indexed-annuity sales will increase as well but not as much as the other product types. It will be hard to get people excited about upside potential when the stock market is in the doldrums. In addition, caps and participation rates are likely to decline, because market volatility will make options more expensive and also because rates are dropping in general. However, many indexed annuities probably will continue to offer attractive short-term rates in their fixed accounts. This, along with generous premium bonuses to accumulation values and income accounts, will help sales. We also expect to see signifi- cant sell-them-while-you-can activity in response to the possible implementation of SEC Rule 151A, which will regulate these annuities as securities in 2011 if legal challenges are unsuccessful.

Broker-dealers will become a more important fixed annuity distribution channel, partly because many indexedannuity issuers will seek to establish or expand B/D relationships in preparation for possible implementation of Rule 151A. (But indexed annuities may not be as successful in the B/D channel, partly because commissions will be lower.) In addition, a number of insurance companies that have focused mainly on variable annuities will instead place an emphasis on fixed annuities in 2009, and these companies already have long-standing distribution through B/Ds. And the channel demand will be there, because many insurance-licensed registered reps will find it easier to sell fixed annuities than VAs or mutual funds in 2009.

This is one of the reasons that there's likely to be a shift in the identity of the key fixed-annuity issuers in 2009. In addition, we think some insurance companies will decide not to offer competitive credited rates, even though the interest rate environment makes it possible for them to do so. Fixed annuities require substantial reserves, and some issuers will choose to use these reserves to back higher-margin products such as life insurance or keep them uncommitted at a time when additional capital is hard to come by. Finally, we expect to see a flight to quality, with business flowing to the stronger companies – mainly mutuals – in response to the downgraded ratings of other carriers. Weaker insurers are likely to merge with stronger partners or get out of the annuity business entirely.

So all in all, we think that 2009 will be another record year for fixed annuities, provided that the public does not lose confidence in the stability of the life insurance industry. Sales could hit $120 billion if present trends continue. And the longer-term outlook is positive as well. Growing numbers of people in or nearing retirement will boost demand for conservative investments. We also think the current downturn may well affect investor behavior even after the economic recovery, with a significant segment becoming more conservative for years to come.

Jeremy Alexander is president and CEO of Beacon Research. Beacon tracks fixed and variable annuity sales, rates and features. It licenses product information and provides data and software for annuity distributors' web sites. Carriers use its tools at for research and sales support. [email protected].

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