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State of Affairs: Help Clients Deal with Longevity Risk

Don’t let demographic headwinds stall your agency’s growth—face them head on by helping clients deal with longevity risk.
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Independent agents have faced numerous exogenous threats over the years—some real, some exaggerated. Today, there is a fair deal of anxiety regarding the challenges that direct writers, InsurTech and autonomous vehicles represent. Yet, there is one trend that may prove to be one of their most difficult—the aging U.S. population.

With some 10,000 baby boomers retiring every day, they are downsizing their homes and reducing vehicle ownership. As a result, property and casualty insurance agencies that have meaningful personal lines books of business have probably experienced these trends in their agency premium volumes.

Another concern is that the economic ripples from the Great Recession in 2008, burgeoning student loan debt and other societal factors have resulted in a later average age for marriage and a decrease in birth rates, which both portend a less robust consumer accumulation pipeline.

Another factor influencing the economy is that while the U.S. is experiencing a historically low unemployment rate, over the past two decades the middle class has experienced stagnating real income growth, making homeownership out of reach for a growing segment of the population.

As of 2019, the states with the fastest-growing population are Utah, Arizona, Florida, Washington, Colorado, Texas, South Carolina and North Carolina, according to the U.S. Census Bureau. Independent agencies located in the Northeast and Midwest have been dealing with flat or slightly declining populations. However, those same trends can be a valuable avenue for their personal lines book of business.

Facing the HeadwindsState of Affairs

Independent agents navigating demographic and business challenges may be overlooking opportunities right in front of them. In dealing with business uncertainties, diversification of the agency’s services can be a key strategy to weather future challenges. To that end, there is one other important demographic trend that agencies should consider tapping into: longevity.

Americans are living longer, especially when measured from age 65. This is great news, but it increases the possibility that people will outlive their ability to maintain a comparable standard of living in retirement. This is known as “longevity risk,” and there is a great deal of anxiety surrounding it. The graphic (right) illustrates the very visible shift in demographics by age group.

The 2018 Agency Universe Survey indicates that over 95% of all independent insurance agencies are licensed to sell life insurance to help clients deal with the financial consequences of mortality risk. However, compared to life insurance, longevity risk represents the opposite side of the coin—outliving one’s financial resources.

At some point, agents who sell life insurance will hear the old and incorrect customer rejoinder that “buying life insurance is betting against yourself.” When it comes to longevity risk, purchasing a lifetime annuity is “betting with yourself.”

Dealing with Misconceptions About Annuities

While the data indicates that most independent agencies offer life insurance, most do not offer annuities. And there are several reasons why, starting with confusion surrounding the word itself.

In its simplest form, a lifetime immediate annuity is a contractual obligation with an insurance company to provide lifetime income and, if desired, to a spouse or beneficiary, in return for a lump-sum premium payment or series of payments. Essentially, an individual is transferring the longevity risk to the insurance company.

In the pre-401(k) retirement world, the most common form of retirement was the monthly pension. And, for government, trade union and many employees of large companies, they will still receive monthly pension checks when they retire. Of course, there is also Social Security, which many people are dependent on for a majority of their retirement income. Given the complexity and anxiety surrounding investing lump-sum retirement accounts such as 401(k) plans and IRAs, why aren’t more people choosing to use a portion of those funds to receive guaranteed monthly income?

While it seems inherently logical that retirees would gravitate toward the lifetime guaranteed income that immediate and deferred annuities provide, there are also several obstacles—real or imagined—which have held back more widespread appeal:

1) Multiple categories. The annuity category is very broad and ranges from the more straightforward single-premium immediate annuities (SPIAs) to the very nuanced and complex fixed index annuity and variable annuity. The consumer media has lumped criticism regarding the more complicated variety in with traditional immediate annuities, which has resulted in adverse public reaction.

2) Lack of financial literacy. Consumers are often mistaken about how much a lump-sum 401(k) balance or other savings can provide throughout retirement. For a healthy person planning for a 30-year retirement and having some funds in stock to avoid a high probability of running out of funds, financial planners recommend that retirees withdraw no more than 4% annually to maintain an inflation-adjusted standard of living. This means that a retiree with $500,000 in their 401(k) should consider withdrawing no more than $20,000 annually. Yet many retirees are taking much larger annual withdrawals.

3) The low-interest-rate environment. On one hand, lifetime annuity payments are lower than they were 20 years ago, and mortality gains also impact pricing. But that also means retirees are receiving lower interest payments on their bonds and certificates of deposits (CDs) and desire other forms of low-risk retirement income.

4) Change in circumstance. Retirees are concerned about tying up some of their retirement savings in an annuity, and then an unforeseen financial need arises.

5) Ability to offer. Independent agents don’t realize that security licensing is not required to offer immediate and deferred income annuities to their clients.

The Power of Mortality Credits

To respond to these perceptions, it’s important to understand a fundamental characteristic of a lifetime annuity: the mortality credit. With a lifetime annuity, premiums paid by those who die earlier than expected contribute to gains of the overall pool and provide a higher yield or credit to survivors than what could be achieved through individual investments outside of the pool. As a result, mortality credits increase significantly with age.

While an individual may die sooner or live much later than the average lifespan, insurance companies use the “law of large numbers” to compile mortality data and underwrite the risk. It is the mortality credit that allows annuitants to hedge their longevity risk, often receiving a return that would be impossible to match in the broader financial markets given a comparable level of risk.

It’s important that agents realize—and should not let their clients lose sight of the fact—that annuities are an insurance product even though they are too often analyzed as an investment, which is only half the equation.

To illustrate, consider that a 70-year-old male would receive on average $567 a month for his lifetime by purchasing a $100,000 SPIA at current rates. Meanwhile, a 70-year-old female would receive $534 a month, due to her longer life expectancy. While an internal rate of return can be projected assuming achieving a certain age for an annuitant, such as 80 or 90 years old—the most important aspect of the SPIA is guaranteed lifetime income.

However, one chief concern surrounding annuities is inflation. This can be partially mitigated by adding an inflation rider to the SPIA with a set annual increase, such as 3%. However, the monthly payout starts at a lower amount to offset the cost of the inflation rider. From an asset allocation standpoint, SPIAs should represent just one tactic among others, such as investing in stocks and TIPS (Treasury Inflation-Protected Security) for retirees. Social Security’s cost-of-living adjustments also help offset the impact of inflation in retirement.

Concern about lack of liquidity surrounding SPIAs can be addressed through withdrawal riders that allow the annuitant to withdraw a portion of their annuity in the first 10 years. Lastly, while retirees would like to leave their loved ones a financial legacy, they are increasingly more worried about being a financial burden, creating a “reverse legacy”—which means that instead of providing their kids with an inheritance, their kids might feel compelled to subsidize their parent’s retirement.

Trusted Choice® Sees a Win-Win

In response to this environment, Trusted Choice® is partnering with two well-regarded insurance companies and providing the tools to address this need. “The reluctance among consumers and agents to consider annuities is probably due to the confusion about their primary benefit of guaranteed lifetime income,” says Robert Holt, Big “I” vice president, life & annuity business development. “That’s why Trusted Choice thought it was important to take this initiative starting with two industry leaders—Nationwide and Principal Financial Group—to help our members meet their clients’ longevity risks.”

Trusted Choice is launching a member-only annuity platform that will provide SPIA and DIA (Deferred Income Annuity) quotes from two industry leaders. The platform accesses sales illustrations and facilitates the quotes through CANNEX and EBIX, two well-regarded technology firms.

Furthermore, most states require a four-hour, online-annuity-licensing class for agents that have a life insurance license. Members can access the licensing class online through the Agents & Brokers Education Network (ABEN). Members that participate in the Trusted Choice Personal Pension initiative will receive product training, sales materials and learn how to talk to clients about longevity risk.

“We are excited to partner with Trusted Choice to bring tools and resources to help agents and their clients deal with longevity risk,” says Sara Wiener, assistant vice president for annuities at Principal Financial Group.® “At Principal, we understand retirement income issues and provide innovative products and resources for agents, while making it easy to do business with us. We’ve had great success with the independent agent channel for life and disability insurance and believe that annuities offer a complementary avenue for independent agents to provide to their clients.”

“If the reason clients save for retirement is to provide a secure lifestyle, there’s no more efficient way to create guaranteed lifetime income than with an annuity,” Weiner adds.

Given the well-publicized lack of retirement readiness, the recently enacted SECURE Act, effective Jan. 1, has a number of provisions that promote the concept of lifetime income through the use of annuities and is receiving a lot of media attention, which is helping to create awareness among consumers.

For independent agents that are considering offering SPIAs, agent commissions generally involve a one-time payment of 3%, which translates into $3,000 for a $100,000 SPIA. To ensure that the agent’s recommendation for an annuity is suitable, an important component of the application process is gathering related client financial information to understand the client’s objectives.

Agents should also be aware that the National Association of Insurance Commissioners has adopted a “Best Interests” standard of its own, and most states are likely to consider adopting this proposal in the coming months. That draft, which also would impose a series of new disclosure requirements and other obligations on producers, applies only to annuity transactions and does not apply to life insurance sales in the way that a more onerous New York regulation does. Trusted Choice will be providing education and materials to help agents comply with the new standard in those jurisdictions that implement it.

“Nationwide has a rich history with independent agents, especially in the traditional insurance products space, and we recognize the value those agents bring to their clients,” says Mike Morrone, vice president of annuities for Nationwide. “Those relationships can extend to providing retirement solutions, such as annuities. As a long-time Trusted Choice company partner, we see this as a great way to offer our brand to agents and consumers.”

Running a successful business involves gauging future trends. Independent agents have a strategic opportunity to serve their clients’ needs for guaranteed lifetime income and ensure their agency’s and clients’ financial longevity.

To learn how your agency can participate email Robert Holt or call 703-706-5434.

Dave Evans, CFP, RICP is a financial planner and former IA publisher.

Image Source: National Populations Projection 2017, U.S. Census Bureau.