#64 | Structured Annuities – Part 1

There’s a tipping point in our industry when, inevitably, a product category goes from being talked about in boardrooms as “a niche market” to something that anyone can obviously see is the next big thing. It usually happens when the status quo product is in peril. Right now, carriers traditionally strong in the VA space are watching their sales take a nosedive and they’re looking for other options. Fixed Indexed Annuities are obviously on the table but, as many of them are finding out, competing in the FIA space means duking it out with a bunch of companies who play by a different set of rules and taking on interest rate and longevity risk that is not so different from their core annuity businesses. So how is an insurer supposed to grow annuity sales without giving away the house? Enter Indexed Variable Annuities. Or Buffered Annuities. Or Structured Annuities. Or whatever you want to call it – that thing that sits between FIAs and VAs and is sold only for accumulation. Yeah, that thing. I’ll take $5B of deposits in that thing every year, thank you very much.

Let’s get the name issue out of the way. These are not Indexed Variable Annuities because Brighthouse files their product as a Deferred Annuity, not a VA. These are not Buffered Annuities because Allianz sells an option that gives the client a floor rather than a buffer. The best label for these products is a Structured Annuity, because that encompasses the different filing structures that could be used and, more importantly, the myriad of payoff structures that carriers will inevitably employ with these products. Structured Annuities is also the best label because it draws a very relevant connection to the Structured Note market, which in every way dwarfs the Structured Annuity market and will be the topic of future posts. But, for now, I’m going to stick with the annuity discussion.

So what exactly is a Structured Annuity? The best description is by comparison – it’s an FIA where the client can have a loss. The same crediting mechanics, basic policy construction and hedging strategies apply. There are a few key functional differences though. First, it’s a security. Second, the assets are generally held in a separate account, albeit a non-unitized, non-insulated separate account. Third, because the product introduces the possibility of loss, the carriers pay a lot more attention to determining an interim account value between when the client receives actual policy credits, so the surrender calculation can be a bit more complex. Finally, because it’s not a fixed product, standard minimum non-forfeiture values don’t apply like they would in an FIA.

The standard Structured Annuity uses a “buffer” strategy, which means that the carrier eats the first X% of market downside and the client eats the rest. For example, a 10% buffer means that an index decline of 5% would result in a 0% credit for the policyholder, but an index decline of 25% would result in a 15% loss for the policyholder. Upside is typically at 100% participation with a non-guaranteed cap on credits. The going rate for a cap on a 1 year S&P 500 account with a 10% buffer is between 7.5% and 10% – quite favorable compared to FIA caps, which are rarely north of 5% for the same underlier and tenor. Most Structured Annuities sell the bulk of their business in long-tenor segments, usually 5+ years, which stands in stark contrast to FIA, where the vast majority of sales are in 1 year segments. More on crediting options and tenors in an upcoming post.

Why are these products so attractive to insurers? I can think of several reasons, but I’m sure there are more. First, and foremost, they are exclusively sold as accumulation products. Income is not a part of the conversation. An accumulation annuity sale means that the profit is based on spread, which is fairly predictable, rather than putting capital at risk based on a variety of other factors, as happens in a guaranteed income benefit rider (GMXB) sale. Second, the profit is entirely under the thumb of the insurer via renewal rate setting. The carrier is under no obligation to maintain its currently stated upside potential. Third, the product may offer some offsetting of risk in the VA with GMXB block they already have on the books. The intuition is pretty simple. If the market goes down, the VA book becomes more of a liability but the carrier gets to pull money out of the Structured Annuity accounts. The degree of actual offset depends on hedging, policy duration, all sorts of things. But the basic intuition is that Structured Annuities provide a natural hedge to VA with GMXB risk. More on this in a later post.

And, of course, let’s not forget that this market is growing dramatically and growth markets attract insurers like flies to a light and, like the flies, they usually aren’t too discriminating about the light itself or the fact that every other fly is making the same move. In the next post, I’ll survey the Structured Annuity landscape as it is today, before it gets muddied by the new entrants. See you next week.