Annuity products have two phases, which are the accumulation phase and the payout phase. Annuity products usually offer options for the payout phase to receive the value of the payout as a single lump-sum payment, as a systematic withdrawal, or as an annuity payment. If the payout method selected is an annuity payment, the accumulation units covert to annuity units in order to create a guaranteed monthly income for a certain period.
The percentage of the total annuity contracts entering the payout phase each year, where the payout method selected is an annuity payment, is the “annuitization rate.”
Annuitization Rates Trending Lower
A trend, reported as long ago as in 1997 by the Wall Street Journal, is for the annuitization rate to be low. At that time, an average annuity holder was 52-years old and many years away from needing retirement money. There was a 10% penalty for withdrawal before the age of 59 ½-years old. In the late 1990s, when the baby boomers were still young, Limra International said the annuitization rate was about 1%.
In 2005, the Gallup 2005 Survey of Owners of Non-Qualified Annuity Contracts (pg. 23) reported that only 17% planned to take the option to annuitize payouts. The annuitization rate was higher than the 1990s, yet still less than insurers expected.
Additionally, wealthy investors who use annuity investments for the tax-benefits of accumulating earnings on a tax-deferred basis, have no need for monthly annuity payments.
A possible reason for a modest annuitization rate is the lack of needing annuity payments, if other funds are available.
In 2013, the Gallup 2013 Survey of Owners of Non-Qualified Annuity Contracts (pg. 27) reported that 24% planned to take the option to annuitize payouts. However, what people say they plan to do and what they actually do may be quite different. Also in 2013, Ruark Consulting reported the actual annuitization rate was below 5% at that time. The Ruark study reviewed 10,000 annuity contracts from seven major insurance carriers to give its report.
Annuitization Rates Correlate with Age
The annuitization rate directly correlates with age of the annuity owner. The highest annuitization rates found by the Ruark study came from the age group of 65 to 69-year olds, because these are the most common ages for retirement. Therefore, the average age of the annuity holders is a key driver of the annuitization rate.
The Influence of Interest Rates
Interest rates also play a significant role in influencing annuitization rates. When interest rates are low, it makes annuitization less appealing because it locks in a lower payout, than if interest rates are higher.
A related phenomenon is the increased surrender rates for Fixed-Income Annuities (FIA) in response to low interest rates, as reported by Ruark during Spring 2016. The Ruark group found higher surrender rates for FIA, when interest credits earned by the annuities are low. At higher levels of interest, there is little effect. However, at very low rates when the interest credits are less than 2% per year, surrender rates are substantially higher. This is corroborating evidence that supports why the sustained low interest rates for the past decade may have negatively affected the annuitization rate.
The Ruark group found higher surrender rates for FIA, when interest credits earned by the annuities are low.
The Impact of Low Annuitization Rates on Capitalization and ROI
A lower annuitization rate increases the need for capital to cover fund outflows. The financial performance of an insurance company is heavily dependent on the investment returns that come from assets under management. Payout of lump-sum payments reduces the capital that an insurer has to manage. This reduces investment portfolio values and decreases overall return on investment (ROI).
When investment returns are low, the financial strength of an insurance company becomes impaired. Conservative short-term cash equivalents, such as Treasury bills, bank CD’s, and money market funds had interest rates of a fraction of one percent for over a decade in the United States. Bankrate reports that money market funds are currently paying the average annual interest rate of 0.26% in October 2016.
The ROI of an insurer’s investment portfolio goes down when it sells longer-term investments, such as AAA-rated bonds, in order to have enough cash on hand to cover lump-sum payment obligations. This reduction in investment capital reduces ROI, which in turn reduces profits. Reduced profits have a negative impact on share value, which reduces market capitalization. This negative domino effect all starts with a lower annuitization rate.
The Impact of Low Annuitization Rates on Risk Profiles of Insurers
Insurers who do not manage their capitalization and cash flows needs properly, may incur an unpredicted inability to meet obligations and then, in the worst-case scenario, face insolvency risk. Insurers that previously had a strategic plan to use higher annuitization rates for determining the level needed for the cash balance should re-evaluate their earlier calculations.
During extended periods of low investment returns from conservative investments, there is a tendency for the investment portfolio managers of insurance companies to seek ways to enhance returns by adding alternative investments to a portfolio. These alternative investments may pay better returns; however, the higher returns come with more risk.
In response to the financial problems caused by the low annuitization rate, the National Association of Insurance Commissioners (NAIC) created the Life Actuarial Task Force during 2016. The goal of this task force is to investigate and identify actuarial problems experienced by insurance companies selling life insurance and annuity products.
One way the NAIC recommends to alleviate the risks associated with a low annuitization rate is by requiring insurance companies to have increased principle-based reserves for non-variable annuities and life insurance. The prediction that the negative impact of low investment returns will continue for the near future, warrants the higher reserve requirements.
Increased Popularity of Deferred Income Annuities
One area of good news for the insurance industry is that the sales of Deferred Income Annuities (DIA) are up. They increased from $1.03 billion in 2012 to $2.67 billion in 2015. DIA offerings are attractive to a younger age group because the payouts are higher when a person invests in a DIA product earlier in life. The longer time remaining to the eventual payout means the insurance companies have a longer term to manage the DIA funds before payout, even if a DIA product is never subject to annuitization.
The trend of lower annuitization rates is something insurers need to consider seriously to mitigate the serious impacts on capitalization and risk. Concentrating on the marketing of DIA products may help alleviate some of the pressures caused by a lower annuitization rate.
|Annuity Holders Steer Clear Of Annuitized Payments |
|2005 Gallup Survey of Owners of Non-Qualified Annuity Contracts |
|2013 Gallup Survey of Owners of Non-Qualified Annuity Contracts |
|Ruark study: Annuitization rates are below 5 percent |
|Key Observations – Surrender and Partial Withdrawal Behavior |
|Life Actuarial (A) Task Force |
|BankRate Money Market Rates |
|Deferred Income Annuities |