A $100 Billion Market for SPIAs?

Income annuities aren't a good product fit for every insurance company. But for New York Life, a mutual company with tons of reserves and a big book of life insurance, they make perfect sense.

As recently as 2004, New York Life sold only $200 million of income annuities annually. But now the trickle of sales is turning into a steady stream. In 2010, sales totaled $1.9 billion, up 9% from the year before. In the first quarter of this year, the figure jumped 45% from the period a year ago. The gains are substantial in a total market of $7.9 billion.

The growth of income annuities is just beginning, predict Chris Blunt, New York Life’s executive vice president of Retirement Income Security. “In the next ten years, this will become a $100 billion market,” he said in a recent interview.

[In the third quarter of 2011, New York Life intends to introduce a product that could make that market even bigger: a deferred income annuity designed to let people in their 50s or younger buy future guaranteed income at a discount.]

As more baby boomers wake up to the need for safe sources of retirement income, Blunt (at left) expects this type of annuity to be a compelling product. Chris BluntRetirees can use income annuities to guarantee themselves enough income to maintain a desired lifestyle for life. The problem so far is that insurance agents and financial advisors have been reluctant to sell them. Commissions for selling income annuities (usually about 3.5% of premium) are low compared to variable annuities and indexed annuities. And clients have historically balked at the product’s inherently low liquidity.

If you’re relatively new to income annuities, here’s how they work. In a typical contract, a 70-year-old man (or couple) might give the insurance company $100,000 and get a fixed annual income for life.

The longer the client lives, the greater the effective return on the initial “investment.” (Income annuities are insurance, not investments, and a widespread misunderstanding of the difference is an obstacle to greater acceptance.) But if the client dies in the first year or two—and if the client hasn’t taken the precaution of stipulating a minimum payout period or of setting aside a legacy—heirs may feel cheated because they have no access to the income or principal.

New York Life, the world’s largest mutual insurance company with some $16 billion in reserves, has to some degree overcome resistance to income annuities with a marketing campaign that emphasizes the value of lifetime income. To explain the value of income annuities, agents contrast them with portfolios of mutual funds, Blunt said.

Blunt cites the example of a 65-year-old man with a $500,000 portfolio that has 42% of assets in equities and 58% in bonds. Each year the retiree withdraws a total that is equal to 4.5% of the initial value of the portfolio. Based on market history, there is a 25% chance that the portfolio will be exhausted by the time the retiree reaches 92. New York Life Ad

He compares this with a portfolio that has 43% of assets in equity, 17% in bonds, and 40% in income annuities. Thanks to the lifetime guarantee on the annuity income, there’s little chance that any combination of planned withdrawals or market downturns will exhaust the second portfolio before the investor dies, so the investor is more likely to have money left for heirs than if he did not have an annuity. Blunt’s example also punctures one of the myths about income annuities: that you have to devote all your savings to it. 

Annuities can deliver higher income because their payment stream includes interest, principal, and—most importantly—the “survivorship benefit.” In a $100,000 portfolio of mutual funds, an investor might safely withdraw $4,500 in the first year. But if the investor puts $100,000 into a life annuity, the annual payout would be about $8,000.

The income is high because of that survivorship benefit. When contract owners die, their remaining principal goes to the insurance company, which uses it to pay other contract owners in the same age-pool. (Of course, actuaries calculate the payouts in advance, before any of the contract owners has died, and there’s a survivorship factored into every payment.)

To alleviate client concerns about losing access to their money, New York Life has been offering liquidity riders. A cash-refund rider, for instance, promises the client and the heirs a return of at least the original principal. Say a client pays $100,000, receives $8,000 income the first year, and then dies. Heirs would get a check for $92,000.

But the cash refund riders are not cheap, because you’re giving up the survivorship credit. In a recent quote, a 70-year-old female who took a plain-vanilla contract got $7,760 a year. With the cash refund feature, the contract only provided $7,071.

Blunt says that New York Life gained a leadership position in income annuities because the company has fastidiously fine-tuned the product. “We have spent five years trying to figure out how to market and position these products,” he says. “For most of our competitors, this is not a core business.”

For insurance companies, income annuities are not highly profitable because they require substantial capital, says Blunt. As a result, they may not be ideal products for publicly-held insurers—such as MetLife and Prudential Financial—which must maximize profits.

But income annuities can be attractive for mutual companies like New York Life, which seeks to deliver steadily growing profits. Unlike many publicly held insurance companies, New York Life came through the financial crisis in good shape. Today’s low interest rates aren’t necessarily good news for sales, but income annuities rates are tied to long-term bond yields rather than short-term yields.

New York Life is unusually well equipped to cope with longevity risk exposure—the danger that life expectancies will surge unexpectedly, perhaps because cancer or other diseases are cured. If that happened, the company would have to pay out far more lifetime income than planned.

But New York Life’s losses would be balanced by gains on the life insurance side. In an era of greater longevity, the company’s life insurance business would pay out less in claims, making the two products complementary. Many competing insurers could not offset the losses because they focus on variable annuities or other businesses that do not benefit from greater longevity.

© 2011 RIJ Publishing LLC. All rights reserved.