Source: NAVA OUTLOOK March/April 2005 Volume 14, Number 2 Page 1 of 4
Payout Annuities AND THE RETIREMENT INCOME MARKET
By Borden Ayers and James R. Sholder As financial service companies continue to explore ways to expand their markets and business opportunities, they are coming to recognize the growing potential for retirement income management products and services. The Needs of a Growing Retirement Market It is no secret that the proportion of retirees in our nation is going to rapidly increase as 77 million baby boomers approach retirement age. Over the next five years, consumers near or transitioning into retirement (the 55-64 age group) will represent the fastest-growing population segment at 3.8% per year – or 4.5 times the overall population growth rate. The 55+ age group will soon account for slightly more than 24% of the total US population. Moreover, this older segment of the population owns a huge and growing pool of assets, much of which sits in their defined contribution plans. Based on research conducted by The Diversified Services Group, Inc. (DSG), we estimate that investible assets (excluding home-equity) in the hands of the 55+ segment currently amount to more than $6 trillion. These assets are generally controlled by the consumer, and will be used to help provide a stream of income during retirement. Recognizing that they will be personally responsible for providing a significant portion of their retirement income, many pre-retirees are looking for advice and solutions that will help them turn their assets into “pensions” or “retirement paychecks.” Providing Retirement Income Solutions These consumer trends will provide major opportunities for financial services firms to offer solutions at each of three stages: prior to retirement, the transition from employee to retiree, and during retirement. How companies position themselves, their products, and their marketing efforts will determine how much of this major opportunity they will capture. Just within the past year, many companies have increased their focus on the retirement income market. In a recent survey of variable annuity companies, for example, we found that 61% of the respondents have expanded their retirement income efforts over the past year, and about one third of those have made “major commitments” in this direction. Along with these changes in focus, many companies are still wrestling with the question, “What makes up a retirement income solution?” While no one expects that immediate annuities will be the only answer, most would agree that annuity payment options can be an important component of the solution to the public’s retirement income needs, since they provide a seamless way to generate a steady stream of retirement income with lifetime guarantees.
Source: NAVA OUTLOOK March/April 2005 Volume 14, Number 2 Page 2 of 4 Although the trend toward the use of immediate variable annuities (IVAs) has not been strong in recent years, there are some encouraging signs that this situation could be poised for a change. Examining the Variable Payout Marketplace DSG recently completed our fifth annual study of the variable annuity payout market. This past year’s study included both an industry survey, and a series of in-depth executive interviews. Selected highlights are provided below. The Market for Variable Payout Annuities As of mid-2004, there were 17 firms providing stand-alone IVA products to the marketplace, an increase of one company since the previous year. There were an additional five firms offering “IVA Substitute” products. (We classify a company as offering an IVA Substitute when it is actively and purposely promoting a deferred variable annuity product, with an intentional focus on its payout provisions, as a substitute or alternative for an IVA. This definition would not include those variable annuity companies which provide annuitization as more of an accommodation than a strategy.) Total industry sales of individual IVAs in 2003 (the last full year of available data) declined for the second year in a row, from $632 million to approximately $550 million. IVA Substitute sales reached about half of that amount, bringing the total of both to approximately $800 million. The average IVA product sale in 2003 was $114,000 per contract; IVA Substitutes averaged slightly less. Product Design The list of available variable payout annuity product features has stabilized, with little change over the past two years. Out of 16 IVA firms that provided product information, 14 now offer some form of commutation option, and about half of these companies offer a “floor” on monthly income payments. There are now three firms (two IVA and one IVA Substitute) that offer a product that pays commissions on the income stream. Guaranteed living benefit options (GLBs) attached to deferred variable annuities continued to grow in popularity as elements of the retirement income plan. Among IVA companies, 71% offer one or more living benefit options with their deferred variable annuity products, and their clients select these options 42% of the time. Several other firms are also planning to roll out these options in the near future. By drawing attention away from traditional annuity payout features, it appears that this emphasis on living benefits may have had a negative impact on recent IVA and IVA Substitute sales. Executive Perceptions Interviews were conducted with a dozen executives at companies that are active participants in the variable payout annuity market. The interviews addressed corporate strategies, competitive challenges, and expectations for the future. Following are selected findings from these interviews: • Most companies continue to use product-focused strategies as their response to a need for retirement income solutions. However, we are beginning to see a few companies enter the
Source: NAVA OUTLOOK March/April 2005 Volume 14, Number 2 Page 3 of 4 market with a product initiative, and then evolve to a more holistic, needs-based income planning strategy. Although these companies did not achieve significant growth in their variable payout annuity business in 2003, many of them continue to be upbeat about the future potential of these products. The most commonly-mentioned problem preventing sales of IVAs is the fact that many advisors don’t understand the needs of this market and how to provide retirement income solutions. From the advisor’s perspective, the perceived loss of the client and asset control continue to be referenced as sales impediments. There continues to be some debate regarding the potential for IVAs when matched against other retirement income solution options such as systematic withdrawal of GLBs. Some companies, taking a “wait and see” approach, have delayed any further development or promotion of their IVA products. Companies are equally split in their opinions of when the retirement income market will fully materialize. They either believe that the opportunity is here already (or on the brink), or they believe it will reach fruition gradually, as boomers retire over the next five to ten years. A few prominent industry leaders are committing substantial resources today to implement their retirement income strategies. Not only are they firmly establishing their competitive advantage, but they may also be raising awareness of the issues, which could be beneficial for the industry in general.
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Changing Consumer Expectations The cautious optimism among some variable payout product providers may be supported by a consumer survey we completed at the end of 2004. Comparing pre-retirees and retirees, we found that employees near retirement have very different expectations about what they will do with their retirement savings and how they will create sources of retirement income. Several findings from that study reflect positively on the outlook for payout annuities. When asked about the disposition of their retirement plan assets at the time of retirement, consumers responded as shown below. Selected Retirement Plan Distribution Choices
Consumers: Age 55+, within 5 years (plus or minus) of retirement date
Disposition of Retirement Plan Assets Convert Assets to Regular Payouts
Pre-Retirees (Expected) 22%
Recent Retirees (Actual) 5%
Recognizing that pre-retirees’ expectations may change once they reach retirement, it is still interesting to see the high percentage of these individuals who are becoming comfortable with the idea of establishing some form of a regular payout program. Probing further, the same consumers were asked what they expected to be their key sources of retirement income. Once again, there were clear differences in the expectations of near-retirees: about 12% of recent retirees are using payout annuities as a source of retirement income, but 35% of pre-retirees expect to use payout annuities for this purpose. Thus, it appears that tomorrow’s retirees are becoming more aware of their personal responsibility to create their own
Source: NAVA OUTLOOK March/April 2005 Volume 14, Number 2 Page 4 of 4 “pension” for life out of retirement savings. Perhaps this reflects the success of recent awareness efforts on the part of our industry. However, it is unclear whether this will result in increasing use of immediate variable annuities and annuitization, or a greater use of the living benefit options. Summary Most firms in the variable payout annuity business continue to be somewhat optimistic about the future of their business, despite the recent market setbacks. Consumer research tends to support their optimism. The evolution toward a broader “retirement income solution” rather than a single product approach continues to be the trend, and some companies are already beginning to provide such solutions. A number of companies are actively building awareness of important retirement issues (among advisors/reps as well as consumers) and applying substantial resources to developing and providing practical solutions. As these firms are positioning themselves to benefit from the retirement income market opportunity, we expect they will be the leaders in the transition from a market based on retirement savings to one based on optimizing retirement income and other post-retirement decisions. Contributed by Borden Ayers and James R. Sholder, principals, The Diversified Services Group, Inc. For more information about these studies or other available research, contact DSG at www.dsg-candr.com.