Could you still sell fixed annuities if interest rates were zero?
By Chris Conklin
Fixed annuity sales continue at a healthy pace despite record low interest rates. What will happen to sales if rates go even lower? And, to take it to an extreme, would fixed annuities still sell if interest rates were zero?
There was a time when people said you couldn’t sell fixed annuities if their interest rates dropped lower than 8 percent. Many of you probably remember those days. Yet, as interest rates have progressively declined over the last 30 years, fixed annuities have continued to appeal to customers and enjoy healthy sales volumes.
Even at today’s record low interest rates, sales continue to increase. LIMRA reports that in the second quarter of 2011, fixed annuity sales grew 6 percent and indexed annuity sales increased 14 percent compared to the prior quarter. Immediate annuities posted all-time record sales results, up 22 percent from prior quarter.
With interest rates so low, it begs the question: What will happen to sales volumes if rates go even lower? To take it to an extreme, could you still sell fixed annuities if interest rates were zero?
Amazingly, the answer may be, “Yes, they could still be sold.” Here’s why:
Consider that interest rates on fixed annuities are typically competitive with and even higher than rates on other relatively safe fixed-rate products such as bank certificates of deposit, money market accounts, savings accounts and Treasury bonds. If the interest rates on annuities are zero, they are zero on those other financial products, too.
Arguably, there would then be no reason to put money in any of those financial products. However, there is still a reason to put money into an annuity, and it is the provision for guaranteed lifetime income.
Consider, for example, a 65-year-old retired person who has $1 million in savings. She is concerned about the safety of her money, yet no traditionally safe financial product is offering any interest. She desires to maximize her standard of living, but planning for the future is uncertain given that she doesn’t know how long she will live.
According to recent annuity mortality studies, her remaining life expectancy is about 20 years, but if she draws her savings down over 20 years, there is a 50-50 chance she could still be alive when she runs out of money. So, she needs to plan more conservatively for the possibility of a longer lifetime. There is only about a 5 percent chance of her living beyond age 100, so she decides to make her planning horizon 35 years. From her perspective, it looks like she can afford to draw down her retirement savings by only $28,571 per year, because $1 million divided by 35 years is $28,571. Let’s suppose that you could offer her a life-only SPIA, a single premium immediate annuity, which pays her annually as long as she lives. The insurer can take advantage of the law of large numbers and the pooling of longevity risk, and thus can afford to base its payouts upon her average 20-year life expectancy rather than her extreme possibility of a 35-year remaining lifespan.
Even assuming zero interest rates, the insurer could afford to pay her $50,000 per year, because $1 million divided by 20 years is $50,000. That’s 75 percent more than she could afford to pay herself. (Of course, the carrier would pay something less to account for its expenses and profit, the agent’s commission, and a margin for adverse deviation. But still, it could provide her with a considerably higher payout than her $28,571.)
Similarly, you could offer her a fixed annuity with a guaranteed lifetime withdrawal benefit rider. While such an annuity would have a declining account value due to the rider charge, the carrier could nonetheless still take some advantage of the pooling of longevity risk and offer a higher guaranteed annual payout than her $28,571. Plus, she would still have access to the remaining annuity account value while it lasts. Even compared to a variable annuity with a GLWB rider, if the guaranteed payout was higher on the fixed annuity, she may find this offer attractive.
You may consider this example ridiculous, but consider that on some fixed indexed annuities today, the index-based crediting potential is so low that the GLWB rider charges may very well exceed the interest crediting over the life of the contract. On these annuities, their account values will most likely decline even before withdrawals are taken … yet they remain popular.
The reason they remain popular is because no matter how low interest rates go, people still have a concern about outliving their money. They want guarantees and certainty. They want checks that they can spend because they know another check just like it will arrive every year that they live. SPIAs and annuities with GLWBs can address that concern, no matter how low interest rates go. Insurers can still create value on these products through the pooling of longevity risk.
While selling annuities would probably be easier if interest rates would increase, we can take comfort in the realization that even if interest rates decrease, fixed annuities still have appeal.
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