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How Creative Destruction Shapes the Fixed Annuity Market

I love economics! As I think of what the annuity business is going through, I think of the economic term “creative destruction” that the great Austrian economist Joseph Schumpeter introduced in 1942. Since then, this term has been adopted by economic practitioners from high school economics teachers to Federal Reserve chairs such as Alan Greenspan.

Creative destruction is the notion that in the process of evolution, free markets can be somewhat messy in making progress. Although the world is a better place because of evolution, progress and upgrades, the process can be quite a disruptor for those who are on the wrong side of creative destruction.

For example, the horse and buggy were creatively destroyed by the invention of the automobile. The bow and arrow were creatively destroyed by the firearm. Although these impacts of innovation may be negative to obsolete products, is there anybody on earth who believes that purging the antiquated to make way for the innovative is negative? Probably not.

As I look at the latest trends in the annuity space, the term “creative destruction” certainly comes to mind. There have been wins as well as losses in the past four years. The variable annuity (VA) product line has struggled. Meanwhile, all four segments of the fixed annuity space — indexed annuities, fixed annuities, single premium immediate annuities (SPIAs) and deferred income annuities (DIAs) — have excelled. I do love and personally sell VAs and predict that eventually they should recover. However, the numbers are very telling.

1Q 2016: The Numbers

Total annuity sales in first-quarter 2016 were $58.9 billion, which was up 9 percent compared with first-quarter 2015, according to LIMRA. This was on the heels of a flat sales year in 2015, with $236.7 billion in total annuity sales.

Variable annuity sales for first-quarter 2016 were $25.6 billion, which was down 18 percent compared with first-quarter 2015. This was the lowest sales level seen in 15 years. This decline was very broad with 19 of the top 20 VA carriers

reporting declines. This comes on the heels of 2015, when variable annuity sales had decreased by 5 percent — marking the fourth consecutive year of contraction. This is the first such four-year drop in the 40 years that LIMRA has been tracking variable annuity sales. VAs now represent only 44 percent of total annuity sales, the lowest percentage seen in more than 20 years.


What is causing this creative destruction in the variable annuity world? The No. 1 instigator was the 2008 financial crisis. During the financial crisis, many manufacturers realized that the “arms race” of guaranteed lifetime benefits (GLBs) had led them into trouble and it was too costly for them to continue offering those living benefits.

This led many VA carriers to exit the VA business. For those that continued, they either eliminated products, “derisked” their GLBs or did both. Carriers’ derisking of the GLBs had a significant impact on election rates and, of course, sales.

For example, at the GLB peak, those benefits were being elected on around 90 percent of variable annuities sold. Then, from 2011 to 2014, the number of variable annuities sold with GLBs had decreased by 28 percent. Over that same time period, sales of variable annuities without GLBs increased by 66 percent.

Again, with creative destruction there are losers as well as winners. Within the confines of the VA world, the winners of this process have been the new VA innovations introduced by the carriers over the past few years. Those recent VA innovations come in three broad flavors: investment-only VAs (IOVAs); VA + deferred annuity (VADAs); and structured product VAs (SPVAs), also known as buffered VAs.


FIAs Maintaining Strong GLWB Features

Fixed indexed annuities certainly have been a benefactor of the creative destruction experienced by their big brother, the variable annuity. FIA sales were $15.7 billion in first quarter 2016, which was up by 35 percent over first quarter 2015.

This is on top of a 2015 FIA production increase to a record-breaking $54.5 billion, a 13 percent increase from the previous year. FIAs have been able to maintain very strong guaranteed lifetime withdrawal benefit (GLWB) features that are more easily hedged within the design of an FIA product than within a VA product.

These benefits that once defined the VA world are now defining the FIA world, as around 60 percent of FIAs sold have a GLWB rider attached. GLWB development on FIAs has been moving at a rapid pace. Furthermore, crediting strategy evolution has been taking off as the manufacturers continue to introduce “uncapped strategies” at a breakneck pace.

In the 21 years (since 1995) that indexed annuities have existed, this product line has seen its share of creative destruction as well. They have evolved from being complex, high-commission and high-surrender-charge products.

For example, the average commission on an FIA 10 years ago (in first quarter 2006) was 8.3 percent. Today, that commission has dropped to 5.4 percent. Furthermore, in first quarter 2006, more than 60 percent of FIAs sold had surrender periods longer than 10 years. Today, fewer than 20 percent of FIA products sold have surrender periods greater than 10 years.

FIAs have not been the only benefactors of the VA business’s contraction. The entire fixed annuity business has seen growth as a result. In first quarter 2016, fixed-rate annuities — multiyear guaranteed annuities (MYGAs) and book value annuities — increased by 90 percent over first quarter 2015.

As banks continue to pay very low interest rates, these products will continue to grow because it is all about relativity. For example, the average five-year certificate of deposit is paying 0.83 percent at the time of this writing, according to Can a five-year MYGA triple what clients have available in CDs? Yes, it is very probable, and without the Form 1099 coming on top of it!

The new kids on the block, deferred income annuities, reached $729 million in first-quarter 2016 sales, which was an increase of 29 percent over first quarter 2015. This product line will continue to proliferate as companies build more and more of these products and leverage the required minimum distribution delaying technique these products offer.

As far as the future of FIA goes, the new source of potential creative destruction is the Department of Labor’s (DOL’s) fiduciary rule that takes effect in April 2017. As we know, the DOL is mandating that FIAs fall under the Best Interest Contract Exemption in order for the agent to get paid commission.

This rule will affect a good amount of FIA business because the new regulation focuses on qualified money. Considering that 60 to 65 percent of FIA sales are “qualified sales,” the DOL rule could have a significant impact on FIAs. Time will tell how significant that impact will be. I tend to be optimistic because I believe in my heart that these products are so good, their popularity cannot be stymied.

Clearly, it has been a great year so far in the fixed annuity/FIA business. Despite the significant storms coming in with the DOL rule, I believe the annuity will be able to put more emphasis on the creative and less on the destruction.


Charlie Gipple, CLU, ChFC, is founder and CEO of CG Financial Group, an independent marketing organization that serves independent agents who sell life insurance, annuities and asset-based long-term care insurance. Charlie may be contacted at [email protected] [email protected].

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