Everybody’s Talking about the Hartford and Variable Annuities

Some questions people may be asking are how this happened, and how it will affect the Variable Annuity industry.

You can read my analysis on the Hartford’s exit from the life and annuities business on March 21 here. Forbes has weighed in now, as well as many other market watchers. Despite the apparent caving to the pressure of hedge-fund manager John Paulson, as the smoke begins to clear, the picture of a perfect storm emerges in 20/20 hindsight.

A Perfect Storm at The Hartford

Buying business through product feature enhancements: It all started when the industry fight over boomer retirement dollars led to  increasingly generous living benefit guarantees. Given the cost of these guarantees and the thin margins of variable annuities, The Hartford became vulnerable during the market collapse of 2008. VAs they sold offered generous living benefits and, in the 2008-09 recession, the cost of providing guarantees and death benefit step-ups caused them to suffer losses, since they were “giving away too much and not charging enough.”  according to one financial advisor. When the market tanked and real account balances dropped, benefits remained guaranteed, putting the company on the hook for large payouts.

Insufficient hedging: It soon became apparent that they hadn’t hedged enough of their exposure. Their share values tumbled, and they cut hundreds of jobs.

Neglecting distribution: Compounding this, the firm pulled back from selling new variable annuities, leading to an outflow of employee talent as annuity wholesalers jumped ship for competitors. Lacking support, financial advisors began to place their business elsewhere. Sterne, Agee & Leach analyst John Nadal says,

“One thing that investors don’t recognize as much as they should is the importance of maintaining distribution…So if your best talent leaves you you’re dead in the water.”

When The Hartford did try to recover with new annuity promotions last year, they had already lost the confidence of the financial advisors who were still wary of how committed the company was to annuities in the long run.

Shareholder activism: Majority shareholder and hedge fund manager John Paulson lost patience with The Hartford and demanded the company divest itself of the unprofitable lines of business. After responding that it would be difficult to spin off these lines of business, The Hartford succumbed to pressure and announced that it would focus on its strong property/casualty business, group-benefits coverage, and its mutual fund operation to concentrate on the “crown jewel” of the company: selling insurance on cars and homes.

More hard decisions to come: It seems to me that The Hartford was telling the truth here – it may be very difficult to divest themselves of their business. Without a viable distributorship, who wants to invest in a losing book of business? To sweeten the deal, they may well have to bundle it with their mutual funds or group business as well.

Growing Public Doubts about Variable Annuities

In the wake of the recent resignation of a Goldman Sachs employee  Greg Smith, whose New York Times op-ed charges that the investment management business had lost its moral compass and was failing to put the best interests of clients first, many critics have emerged to say that financial firms are selling complex products that buyers can’t understand.  let alone profit from them.  Market Watch’s report, “How to avoid becoming a Wall Street muppet” has called for  simplicity, and suggests that investors shy away from  complex, hard-to-understand financial products.

A complex product carries market conduct risk:The Hartford appears to be doing this in dropping their variable annuities line of business. In recent years, as annuities have become increasingly complex, they have gotten bad press and customer complaints have skyrocketed.  To be fair, some of the criticism is unwarrented, as market conduct complaints inevitably rise as returns fall and disillusioned investors lash out with frivolous complaints. But it is true that the complexity of the living benefits are difficult to understand and explain. In the absence of vigilance and the guidance of a financial advisor, it’s easy to make excessive withdrawals that violate the guarantee provisions, voiding guaranteed income guarantees, for instance.

Variable Annuities expose advisors  to risk too: Variable annuities, while designed specifically to mitigate financial risk, expose both clients and advisors to risk.

For example, on Oct. 23, 2011, a 12-person jury found former agent Glenn Neasham, 52, guilty of felony theft  for selling an annuity to an elderly woman.  On Feb. 29, 2012 the judge denied the motion for a new trial, refused to drop the felony charge to a misdemeanor and sentenced Neasham to probation and 300 days in jail. Martin plans to appeal. What did he do that was so egregious? He sold an Allianz MasterDex 10 annuity to an 83-year-old client who, as it turned out, has dementia, although Neasham was not aware of the fact and, according to reports of the trial in the local paper, the client was diagnosed with dementia several years after she purchased the annuity. According to  Life Health Pro:

It appears the jury believed Neasham stole Schuber’s money because her policy had a schedule of surrender charges. Also, they must have thought Neasham, who had no actual knowledge of Schuber’s likely Alzheimer’s, should have known she was suffering from dementia. Her condition has progressively worsened since the annuity sale date — Feb. 6, 2008. She couldn’t testify at trial….It was a perfect storm to punish Glenn Neasham, whose crime was simply selling an annuity.

In an interview, David Saltzman, president of EmpowHR, Inc., in Columbia, S.C., acknowledges he is not privy to all the facts in this particular case, although he says “It seems as though the agent did everything he should have.”  It appears that the annuity actually made money for the policyholder and that the relatives of the woman were consulted before the sale was concluded. Yet the State of California deemed the transaction illegal and charges were brought against the agent.

A miscarriage of justice to be sure, but one that plays to the sympathies of an angry and disillusioned public. California’s legislators have crafted one of the strictest elder abuse laws in the US.

Are Variable Annuities Too Risky?

The Insured Retirement Institute (IRI) reported that net VA sales in the third quarter hit $8.9 billion, a 38 percent rise from the same quarter a year ago and the highest level since 2007.

Yet, in the span of several weeks, even while there has been a rise in variable annuity sales, two large carriers announced their exits from the variable annuities business and another took a large hit on their earnings due to a previous closure of the product line.

  • In December, Sun Life announced it was discontinuing sales of VAs in the U.S.
  • In the same month, ING reported a $1.1 billion hit to its fourth-quarter earnings due to a VA block of business it closed in the U.S. back in 2009.
  • In addition, John Hancock said it was “restructuring” its annuity business saying: “Due to volatile equity markets and the historically low interest rate environment that is expected to continue for an extended period of time, Going forward, our current annuities will be sold only through a narrow group of key partners such as John Hancock Financial Network. John Hancock will continue its award-winning service to its annuity clients, who will see no change in how their accounts are handled.”

Is the sky falling? Not really. Much of this is due to the fact that ING is based in the Netherlands, and John Hancock and Sun Life have Canadian parent companies which,operate under different reserve and reporting requirements. ING must contend with Europe’s Solvency II requirements, which mandate greater capital reserves, according to Cathy Weatherford, president and CEO of the Insured Retirement Institute (IRI) in Washington, D.C. says that carriers are adjusting their product designs to address prevailing market realities. She states:

“We’ve seen significant product retooling over the past three years. We’ve seen significant hedging strategies,” she details. “Many have the ability now to move the money to less volatile fixed incomes if they start seeing market volatility. We know the living benefits aren’t quite as rich as they used to be. They’ve retooled them in a way that they are comfortable with. First and foremost in every insurer’s mind is that they want to be sure they have absolute financial strength so they can perform on the promises they’ve made to policyholders in the products they deliver. “I think each individual carrier makes their own decision based on their own business and distribution models, so I don’t think there is any wholesale answer around this question. But I do believe we are seeing the highest sales since before the meltdown in 2007 this year. So clearly there is available product, and advisors and consumers are gravitating toward them. We have strong carriers who have a robust product suite,” she says. “We’ve seen different strategies with low fees. So I think there are lots of options and opportunities for advisors and consumers.”

Some Thoughts on the Variable Annuity Market

The market remains viable: Health Life Pro says that the departure of the Hartford shouldn’t have much of an effect on the annuities marketCathy Weatherford has stressed that the insurance industry is strong financially and that lifetime income products continue to meet the needs of the retirees and pre-retirees, particularly baby boomers. And Prudential Annuities said that the company “remains committed to the annuity market, and we are comfortable with our overall risk profile.”

Agents need to do more due diligence: Many advisors don’t seem to think it will impact sales so much. In addition to variable annuities, and many have been diversifying into fixed indexed annuitiesMatt Golab, RIA and a licensed insurance agent at Aaron Matthews Financial Resources in Elk Grove, Calif.,says Hartford’s decision has both positive and negative implications for the annuity industry. It’s positive in the sense that a company that may not have been equipped to handle the long-term risk exposure of variable annuities has left the marketplace.On the negative side, one less carrier leaves consumers with fewer choices, and advisors with a tougher job in choosing the right carrier. “It puts a little more work on both the consumer and the advisor to really understand how the insurance company is set up with reserves, how they are taking on risk and what their obligations are for consumers in the future with such things as lifetime income plans and death benefit features, things like that,”

Carriers must better facilitate the sales process : I would add to this that carriers need to do much more to “foolproof variable annuity features by making them easier to understand and more difficult to misunderstand. Fine print disclosures are no longer enough. A concerted effort to educate consumers must be undertaken through better sales collateral and practices.

The potential impact of the Neasham case is a case in point. This case will likely mean a more diligent suitability review when dealing with senior clients due to the possibility of dementia. While most registered representatives are very thorough and consultative in selling variable annuities, suitability will become even more demanding, and may include an evaluation of the client’s medical history going forward, much like the kind of medical questions that you would typically find on a life insurance application.

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