There is a shell game going on in the annuity sales industry and it is putting the life insurance industry and the annuity consumer at greater risk.
In the past 20 years annuities have grown to become the most important sales and revenue source for the life insurance industry. As the sales of traditional life insurance products declined, the annuity, once a staid, boring product considered appropriate only for “widows and orphans” has become the difference between success and failure for insurance companies and the agents who sell the product.
Third quarter sales of fixed annuities increased 50 percent over the same quarter in 2007 and it is estimated that in 2008 the sales of fixed annuity policies will exceed $100 billions dollars. This amount is a significant increase over the past few years and is being ballyhooed by insurance company executives as a demonstration of their great leadership and marketing skills. However, one should be careful not to get too excited over the reported growth in annuity sales, because there is a dirty little secret behind these sales numbers that insurance company managements do not like to acknowledge, let alone brag about.
And that dirty little secret is that up to 70 percent of the insurance industry’s “new” annuity sales are, in fact, not new sales at all, but simply the “repositioning” of annuity funds from one company to another.
The bulk of new annuity sales being reported by the insurance industry do not represent new money entering the industry from banks and investment firms, but “old” money already being held within the insurance industry. The truth is that annuity sales have become a giant shell game in which funds already held by the industry are shifted from one company to another.
It has not always been this way. Twenty years ago virtually all annuity sales represented new money flowing into the insurance industry from outside sources, especially from banks and investment firms. (After all, there had been no real annuity sales effort prior to that time.) The new annuity products were designed to attract new funds into the insurance industry by offering creative, secure and innovative alternatives. But, that has now changed.
The annuity funds held by insurance companies have become like a giant pool of money that sloshes from one company to another. The intra-industry movement of annuity funds has become such a large part of annuity sales that virtually every company working in the annuity market has a specific department (often called “transfer and exchange”) charged with one task: to manage the transfer of annuity funds from one insurance company into another. These funds flow back and forth among insurance companies like cronies playing a weekly poker game.
Certainly a good portion of the third quarter increase in annuity sales was driven by the current financial crisis as the consumers, in a flight to safety, transferred their funds – of what is left of them — out of investment products and into annuities. But it is also clear that a good portion of this “increase” in sales came from funds being transferred out of AIG, Hartford and other companies identified in the financial crisis. There may be good reason for consumers to move funds out of these companies, but it is misleading to consider them “new” sales.
To get a true picture of the actual new sales of annuity products one would have to subtract out all the “transfers and exchanges” made within the industry. But the companies do not want to do that, because it would show a very different picture of value being created by insurance companies and the industry in total. The real irony in this situation is that oftentimes more business is being moved out the back door of one company to other companies faster than “new” business is coming in, and yet the company being raided can still report an “increase in sales.”
This artificial sales process is successful because of a silent back-scratching conspiracy between the insurance company management and the sales agents. Working the system allows the insurance companies to report increased “new” sales and the agents can be paid commissions on this business, even though the same funds may have been “repositioned” multiple times by the same agent.
Companies have become so dependent on this type of “sales” activity that instead of designing products that attract new money from banks or investment firms (admittedly a more difficult effort) the companies design products with bells and whistles that actually target the replacement of other annuities. Some companies go so far as to offer “benefits” that are really designed to offset any penalties another company may apply in an effort to block the movement of the funds.
Who Wins? Who Loses?
It is one thing if insurance executives want to play this game so that short-term sales look better and bonuses increase, but there are potential problems with this game that could be detrimental to the long term viability of the company and, even more important, be harmful to the consumer. It is often the consumer who becomes a simple and unknowing pawn in this game. Their interests can often be ignored when companies seek “new sales” and agents seek new commissions.
Insurance companies may be the ultimate loser in this game because at the time an annuity is sold it is not immediately profitable to the company issuing it. It takes several years for the insurance company to recover this initial loss and even longer for the annuity to be profitable. It has been estimated that the average annuity is “rolled” every three to four years. If that is the case, the companies involved in the process are more like rats on a treadmill constantly running but going nowhere.
The risk for the consumer is that each time their policy is rolled they may end up with less value and less flexibility of action because moving the old policy triggers surrender charges and the new policy starts a new surrender penalty period.
Is there a solution to this dirty little secret of annuity sales? Yes, there are several, but it is not likely that companies or agents will want to implement them because it would put an end to their secret little game.
Companies could start by reporting sales on a net basis, by subtracting the amount of funds transferred to other companies from the amount of new funds brought in. This would place as much value and emphasis on preserving business as it would on attracting funds from other companies. The companies could begin to attract money from outside the insurance industry by designing products that are creative and innovative for today’s needs. The companies could also design products that offer such attractive benefits to long term policyholders that it becomes prohibitively expensive for other companies to design specific replacement products. Dare I suggest that another way to nip this new sales game in the bud is for companies to reduce or even eliminate commissions for those products being transferred from one company to another?
Don’t get me wrong, there are often valid reasons, including competitiveness, value and security, when it is fully appropriate to move annuity funds from one company to another. To eliminate such activity completely would probably be the worst possible result for the consumer, because it would eliminate the need for companies to offer competitive value. What I do take issue with is a system that has as its primary emphasis the shell game shifting of funds from one company to another.
This approach encourages laziness in effort for all parties and adds no real value to the companies or the industry. If allowed to continue, this mix-mashing of existing annuity funds will lead the insurance industry to be one continuing ground hog day when nothing changes and nothing is accomplished. No one ultimately wins in this game—not the industry, the companies or their agents and certainly not the consumer.