By Cyril Tuohy
Here come the good times for life and annuity insurers. After years of declining interest rates, market forces are moving into alignment with equities roaring ahead and interest rates rising. How long both variables will cooperate, well, that’s another question.
For now, though, this is – or it’s about to be – the best of times for the life insurance business according to Dennis R. Glass, president and chief executive officer of Lincoln Financial Group. His company blew past analyst estimates for second quarter operating earnings.
“You now have a good, growing stock market and slowly rising interest rates – that has to be the best economic climate for the life insurance industry,” Glass said last week, speaking during a conference call with analysts.
Yet, even as Glass was waxing bullish on “climate change,” and better times to come, Eric Berg, managing director at RBC Capital Markets, darkened the mood.
Could the “growing share of passive strategies,” used by the asset management business on behalf of individual and institutional clients, throw the entire annuities and guaranteed income business, which subsist on high fees, into question?
Passive strategies, those typically employed by indexed funds and indexed annuities, simply seek to match a benchmark. Because they are tax efficient and cheap, investors enjoy a greater portion of a given market’s return.
“Annuities kind of go in the opposite direction from that trend,” Berg said during a question-and-answer session with Lincoln executives.
Because capital gains are taxed at ordinary income rates upon distribution, annuities are relatively tax-inefficient, and the fee structure is often “dramatically higher” than on index-based alternatives, Berg said.
The question is: can the life insurance industry prevail long-term with their high-fee guaranteed income products against banks and asset managers, and against the predilections of institutional and individual investors toward tax-efficient products?
Glass, in a joking response to Berg’s query, said the answer really was worth discussing over a two-hour lunch.
There are plenty of reasons to have every confidence in the future of guaranteed income and life insurance products. The financial crisis has hammered home the lesson that individuals are, at best, mediocre at investing their money, Glass said.
Too many investors panic and sell when they should hold. Because investors are not good at timing markets, performance lags the S&P 500 by 2-3 percent. And that is before fees, after which investors lag the market by even greater margins.
In many ways, then, investors are often better at losing money, as many industry sages like John Bogle have pointed out. The financial crisis simply reaffirmed that, as well as the importance for investors to have a source of stable, guaranteed income.
“I remember during the crisis, people started referring to the 401(k) as the 201(k),” Glass said. In the wake of the financial crisis, investors have made a “dramatic move” to have a portion of their portfolio invested “in something that has more certainty.”
Even with pressure from banks and asset managers, life insurance and guaranteed income provide a fundamental need for many Americans that other companies don’t offer: protection from adverse events and premature death of the family breadwinner, for example.
For those reasons, life and annuities are going to continue to be “very popular over the next decade,” Glass said.
Glass said that while no one can predict the future, a growing stock market and slowly rising interest rates “has got to be absolutely the best economic climate for the insurance industry on top of the demand that we’re talking about.”
Is Berg, the Wall Street analyst, on to something here? Or should we believe the clear-sighted veteran executive? For the time being, Glass seems to have the upper hand, and given second quarter performance, he has the numbers to back him up.
Second quarter net income, at $317 million, was essentially flat compared to last year’s $321 million, but operating income rose 10 percent to $351 million, or $1.27 per share diluted, compared to $319 million, or $1.09 per share diluted, in the year-ago period.
Operating results far surpassed Zacks analysts’ consensus of $1.15 per share, and much of the increase was due to the strong performance of the annuities segment. Income rose by 23 percent to $195 million, the company said, the result of raising prices and scaling back some of the products' features.
Of the $3.9 billion of variable annuity gross deposits in the second quarter, 80 percent included a guaranteed living benefit rider built on risk-managed funds, with prepayment investment income increasing earnings by $9 million, the company said.
Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].
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