FIAs Produce Steep Shock Lapses

By Linda Koco
AnnuityNews

Fixed index annuities tend to experience “steep” shock lapses following the end of their surrender charge period, according to a new study by Ruark Consulting.

Shock lapses refer to the spike in policy surrenders that typically occur in the first year following the end of an annuity’s surrender charge period.

During that one-year period, “shock lapses increased by about five times the average lapse rate that occurred during the actual surrender charge period,” said Peter Gourley, who is vice president of the actuarial consulting firm.

The findings are based on an analysis of in-force indexed annuities from 12 carriers from 2007 through third quarter 2013. The study consisted of 9.3 million “contract years” (total in-force years for all contracts studied) and 380,000 surrenders.  Roughly three-fourths of the contracts studied had surrender charges of 10 years or more, and only about 2 percent of the total annuities studied had reached the end of their surrender charge periods.

The surge

The surge in shock lapses probably is not “shocking” news to annuity veterans. In general, the industry expects surrenders will jump once the penalties for early surrender have evaporated. As Gourley told Annuity News, “The surrender charge works as barrier. It deters policyowners from taking their money out of the contract.”

Once the barrier is gone, he continued, “it’s a natural time for policyowners and advisors to revisit the plan, and it’s an opportunity for the advisor to shop around for something that might be better.”

Actually, in Gourley’s opinion, a lot of the shock lapse activity in fixed index annuities is driven by independent advisors.

The assessment reflects an analysis of patterns already established on the variable annuity side of the industry, he said. In that business, a mix of distribution channels contribute to overall sales, he explained, but it is the independent agent channel that generally has lower persistency than, say, career agents and banks.

By contrast, in the indexed annuity business, he said, sales are dominated by independent agents. This is even though a variety of channels do sell the products. Here too, the independent agents are known for their tendency to “move the money” once the surrender period ends, he said. “They start looking for products with newer features, better rates or other improvements that will appeal to their clients.”

For that reason, he said he thinks that a substantial portion of the shock lapse rate increase detected in the study reflects the recommendations and involvement of independent agents.

This may be disappointing to carriers that want to see persistency for fixed index annuities increase, Gourley allowed, “but carriers are aware that this happens.”

In fact, he suggested that the trend has contributed to the frequent product redesigns in recent years, as carriers moved to keep their indexed products attractive.

Carrier de-risking strategies have also spurred product changes, he conceded, noting that the low interest rate environment and the regulatory attention on risk protection have fueled this. However, he added, “the carriers are looking for balance. They want attractive new designs and but not with features that put the company at risk.”

Living benefits riders

The presence or absence of guaranteed lifetime withdrawal benefit (GLWB) riders may play a role in annuity shock lapse rates trends, too. 

In the fixed index annuity industry, the GLWB features became fairly prevalent in the latter half of the 2000s as a means of providing a guaranteed income solution for security-minded clients. But the riders did not gain a strong foothold until the last four years or so. By comparison, variable annuities have been offering the riders, in one form or another, for more than a decade.

The Ruark researchers decided to look at the surrender rates and shock lapse rates of both types of annuities, both with and without GLWBs attached, to see if there are meaningful parallels. They discovered that:

• Fixed index annuities without the GLWB riders have shock lapse rates that spike up even higher than for shock lapse rates for variable annuities without GLWBs — and the shocks are high in both types of products. If the products don’t lapse during the shock lapse period, the policy surrender rates drop back down to single-digit territory.
• Fixed index annuities with the GLWB riders, “though early in their history,” generally have annual surrender rates that are one to three points lower than indexed contracts without GLWBs.
• Fixed index annuities with the GLWBs tend to have slightly higher surrender rates than variable annuities with GLWBs. 
• Variable annuities with GLWBs have substantially lower shock lapse rates than variable annuities without GLWBs. But the jury is still out on shock lapse rates for the comparatively younger fixed index annuities with GLWBs. That’s because most of these younger products have not yet reached the end of their surrender charge period.

How to assess indexed annuities in view of the shock lapse findings? Gourley had this to say: “The surrender charge is a reminder that annuities are built for the long-haul. It’s not for people who intend to move money around. If that’s what you want to do, an annuity of any kind is not for you.”

Linda Koco, MBA, is a contributing editor to AnnuityNews, specializing in life insurance, annuities and income planning. Linda may be reached at [email protected].

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Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].