Kings of the Hill: Indexed products spur life, annuity sales

When Sheryl Moore started her market research company 17 years ago, there were exactly a dozen indexes on which one could earn interest from an indexed annuity product.

Today, there are at least 150 different indexes being tracked by Wink Inc. and Moore, president and CEO of the company. Ninety-four percent of them are hybrid indexes, which include a mix of one or more indexes, plus a cash or bond component.

Hybrid indexes are the biggest trend in the most popular segment of insurance product sales.

“It’s just crazy to me how this has evolved,” Moore said. “It’s the most prolific trend in product development of indexed annuities right now, and it’s bleeding over into indexed life as well.

More recently, registered indexed-linked annuities (RILA) rocketed up sales charts, with more and more insurers creating their own RILA products to compete.Today, when you take a look at indexed annuity sales, more than 60% of all allocations are to these hybrid indexes. That’s just a huge, huge shift from where we were even a decade ago.”

Indexed products are largely responsible for the massive tailwind boosting life insurance and annuity sales over the past 30-plus years.

Indexed universal life insurance and fixed indexed annuities are some of the bestselling products in any agent’s portfolio. Product sales and innovation soared to greater heights following the industry’s 2010 success keeping indexed products excluded from securities regulation.

The good times might not last forever, but experts say indexed products are sure to continue selling well as interest rates climb and even if the economy slumps into a recession — in fact, maybe better. A common feature of most indexed products is the zero floor, star of many a “Zero is Your Hero” marketing campaigns reminding clients that they will never lose money.

It all sounds rosy for indexed products, but critics remain. Regulators are lurking. And class-action lawsuits are being heard in more than one federal courtroom.

Inflation-driven changes

The U.S. economy is not doing great two years after the start of COVID-19 pandemic. Uncertainty over everything from gas prices to staffing has businesses jittery and consumers paying hefty inflationary prices.

In response, the Federal Reserve raised its benchmark borrowing rate in March for the first time since late 2018, increasing it by a quarter of a percentage point. Two months later, the Fed hiked rates half a point, sending a sharp message in the process.

Investors expect the Fed to continue raising rates through the end of 2022, putting the federal funds rate in a range between 2.75% and 3% by year’s end.

Given their safety features, indexed products are possibly more popular in times of economic turmoil. In fact, the stock market pullback in 2022 is giving indexed annuity sellers a great story to tell, said Michael J. Eustic, head of insurance at Invesco.

As this issue went to print, the Dow Jones Industrial Average had plummeted nearly 15% in 2022. Having a no-loss investment hedge product really shines amid a market slide, Eustic said.

“There’s not a client out there who bought these products who is disappointed with the results,” he added. “What they got did exactly what we said it would do to protect them.”

In a simple comparison on investment options, life insurance and annuities do very well. And indexed products are leading the way.

Total 2021 indexed annuity sales were $65.5 billion, according to Wink. While the 3% return annuities offer is not a financial windfall, Moore noted, it is very good relative to where fixed instruments are right now. CDs and checking accounts come with an interest rate of less than 1%.

RILAs are on track to set another sales record in 2022 and are averaging annual point-to-point caps of over 6%, Moore said. Some life insurance products are doing even better, she added.

Interest rate dance

The pace of interest rate hikes is of great importance to life insurance and annuity sellers. A panel of insurance executives debated several scenarios during the Insured Retirement Institute annual conference in May.

“What I would say is that rising interest rates are kind of a double-edged sword,” said Mike McCarthy, vice president, distribution strategy for Prudential. “Slow and steady is good. But fast and furious could be bad and potentially disastrous.”

The Fed released a May report that looked at two different scenarios: slow, sustained rates increasing over time and a short-term significant rise in rates.

The former scenario is considered good for insurance companies and their earnings. It also dissuades them from looking at investing in potentially illiquid highly interest-rate-sensitive investments, McCarthy explained.

But the rapid rate increases bring the “potential of having large amounts of life insurance policies surrender, annuity contracts surrender, because investors have an opportunity to drive higher yields elsewhere,” he added. “So, what I would say there is to make sure you know who you’re doing business with.”

In a recent interview with The Wall Street Journal, Fed Chair Jerome Powell vowed to hike rates again and again if needed to bring inflation down to the Fed’s 2% target.

“We will go until we feel we’re at a place where we can say financial conditions are in an appropriate place, we see inflation coming down,” Powell said. McCarthy cited two other reports that paint a troubling picture for insurers if rates rise too quickly:

» An April Moody’s report studied the impact of a 3% rise in long-term interest rates. The report pointed out that the leverage ratio — the ratio of assets to equity — is currently at a 20-year high among life insurers, McCarthy noted. That ratio stands at 12-to-1, compared with that of P&C channels, where it’s 3-to-1.

“It’s significant,” McCarthy said. “Over the past 10 years, as insurance companies have stretched for yield, what they’ve said is that more and more of their portfolios are going into illiquid investments like CLOs [collateralized loan obligations] and are going into commercial real estate debt. This stuff is highly sensitive to the movements in interest rates.”

» In October, the International Monetary Fund released “the most ominous” report, McCarthy said. It concluded that a rapid rise in interest rates would cause “massive disintermediation” and could lead to U.S. policy surrenders totaling $550 billion.

Opportunity for indexed annuities

An Insured Retirement Institute panel agreed that rising rates could open the door for annuities sold with risk-controlled indexes. These types of products will utilize, for example, a heavy bond component in order to remove the risk elements, explained Pete Miller, insurance research strategist with Invesco.

“I think for FIAs [fixed indexed annuities] in particular, that’s likely to get substantial share flows in the coming months, quarters, years,” Miller said. “Because those products do often utilize these risk-controlled and hybrid indexes, I think that’s a tailwind for that type of index.”

With the 0% floor, FIA owners can never lose money. Fixed products are traditionally more popular in economic downturns.

Fixed annuity sales overall took off in March, coinciding with the first Fed rate increase. Fixed indexed annuity sales were $16.3 billion, 21% higher than in the prior year, the Secure Retirement Institute reported. Year-over-year sales increased 10% in the first quarter to $16 billion.

FIA indexes normally have a 10- to 20-year “lookback” period to determine performance. In the present environment, that lookback period will make FIA products look more attractive, Miller said. These products are due to change, however, he added.

“The next 10 years look quite different,” Miller said. “How do we design a hybrid index or a risk-controlled index where we still need that bond exposure, but it needs to be somehow more thoughtfully designed, maybe more dynamic, somehow have something incorporated that can manage that duration risk?”

Hybrid index controversies

Not everyone is a fan of the exotic hybrid indexes. Regulators, for one, are downright uncomfortable about some aspects of the indexes, like when they are used in illustrations that clients may not fully understand.

Most major carriers selling indexed products developed their own proprietary indexes, accounting for the 150 indexes Moore is tracking. What gives regulators heartburn is the lack of appreciable history with the mishmash of indexes, she explained during a May webinar.

A standard index, such as the S&P 500, has a lengthy history of returns, upon which a reasonable illustration projection can be made simply by looking back.

“When I looked at all the new hybrid indexes for last year, I think the statistic was … 92% of those indexes were not even 10 years old,” Moore said. “So, we don’t have a lot of history for those indexes. That’s a problem when you’re trying to say, here’s the past 10 years of history of this index that hasn’t existed for longer than a year.”

The problem comes when agents sell products using illustrations of possible returns. Carriers argue that the components used to create their indexes have enough history to allow for illustrations.

A National Association of Insurance Commissioners working group debated the issue over several meetings in 2018 and 2019 before ceasing work. A 2019 proposal put forth by John Robinson of Minnesota would have doubled the time indexes must be in existence from 10 to 20 years to be used in annuity illustrations.

Industry representatives balked at the proposal, and it died.

“I’d love to see something happen with that,” Moore said, “but it’s kind of stalled. This is an illustration issue. It does not affect the product development at all, because the NAIC is not putting any boundaries on what can be developed and what can’t.”

While the NAIC’s work on indexed illustrations is dormant, its Indexed Linked Variable Annuity subgroup is busy trying to rein in RILAs. The subgroup is working on an actuarial guideline for technical changes to RILA values that would bring the products in line with traditional variable annuities.

Regulators are concerned about RILAs because they do not exactly fit two key model laws: Model 250, Variable Annuity Model Regulation, and Model 805, Standard Nonforfeiture Law for Individual Deferred Annuities.

The former sets the nonforfeiture rules, or the rules that determine how much money a contract holder can get back if they give up the annuity, for traditional VAs. The latter set the nonforfeiture rules for fixed annuities.

While RILAs are closer to variable annuities, and classified as such by some, they do not fit into Model 250 because their daily values are not based on the value of units of a separate account. Rather, the daily values are based on formulas set forth in the contract.

As of press deadline, subgroup members were still meeting to discuss how to regulate RILA values.

Regulators explained their reasoning during a December meeting: If a RILA owner is being subject to the risk of loss, then the contract holder should also benefit from gains, in the actual separate account assets or hypothetical portfolio assets.

Collapse of IUL?

Indexed universal life insurance is a product that is popular and controversial at the same time. IUL premium grew by 21% in 2021, LIMRA reported, and held a 25% market share.

But the product is dogged by allegations of improper sales practices and unrealistic illustrations. The IUL cash value is tied to an index, of course, but the associated “options budget” is where things get tricky.

An options budget facilitates the purchase of the underlying index at a certain time at a certain price, which can rise or fall. Exercising the option at the right time is crucial and can result in a healthy profit. But if the option expires before hitting on that windfall, the money invested in the option is gone.

The insurer controls the options, while the client gets the security of life insurance, with a chance to rake in market gains. But it doesn’t often end up as rosy as promised, said Larry J. Rybka, CEO of Valmark Financial Group.

Rybka is a persistent critic of indexed products and noted the results regularly fall short of the expectations set forth in sales proposals.

“The market volatility of the first quarter certainly highlights one of indexed annuities’ and life’s most compelling features: having a floor of zero,” he acknowledged. “That being said, all is not well in the land of index IUL and especially when it comes to premium-financed IUL.”

Rybka is predicting a 2022 collapse of the IUL premium financing market. Premium financing uses borrowed money to pay for life insurance premiums. This tactic is most often used with very large policies, so that policy owners do not need to tie up their own capital.

“The end of 2021 certainly gave us some clues as to what might be coming here,” Rybka said. “First, it starts with basic economics. As bond rates continue to fall, and portfolio rates drop, the options budgets for IUL products continues to drop, forcing caps lower and lower… . This means complete devastation for IUL premium financing programs that rely on them.”

As clients see “just how far off they are from their original sales proposal,” Rybka added, “we will likely see litigation increase dramatically.”

Courts already busy

If Rybka’s vision comes true, more litigation will only add to the legal issues with indexed products. Two issues attracted plenty of industry attention in recent years and seem destined to remain unsettled:

» Class-action lawsuits claiming that proprietary indexes are little more than a “fraudulent scheme.”

» A pension scam that was applied to hundreds of IUL sales before collapsing into a series of lawsuits and the bankruptcy of a midsized Arizona independent marketing organization.

On the former issues, lawsuits were filed in Florida, California and Kansas alleging that Security Benefit Life Insurance Co. misled consumers via a proprietary index used in two fixed indexed annuities. The complaint is a common one with proprietary indexes: plaintiffs claimed Security Benefit manipulated clients to invest most of their FIA account values in the company’s synthetic index, which performed far worse than portrayed.

Plaintiffs claimed that two of Security Benefit’s FIAs, the Total Value and Secure Income annuities, were offered with proprietary indexes that the company advertised as “capable of producing double-digit returns.”

Generally, annuities are marketed with a cap or participation rate that leaves owners with less than 100% of the market gains. In exchange, the client is protected against market losses. The plaintiffs say Security Benefit marketed its TVA products as “uncapped” and with a “100% participation” rate.

In a February 2021 decision, U.S. District Judge Holly Teeter sided with Security Benefit in dismissing the class-action lawsuit.

“To the extent Plaintiffs allege that the hypothetical illustrations were misleading because they were based on ‘cherry-picked’ time periods of ‘non-representative historical performance’ that Defendant ‘knew’ could not be repeated, the Court finds no factual support in the first amended complaint that backs up these conclusory allegations,” she wrote in a lengthy opinion.

The nine defendants appealed to the 10th Circuit Court of Appeals, where arguments were heard in November. As of this issue’s print deadline, both parties awaited a decision.

Pension scam alleged

Minnesota Life Insurance Co., along with its IUL products, found itself dragged into a wide-ranging nationwide fraud case that attracted federal authorities and is taking years to unwind.
The fraud played out in courtrooms across the country in 2021, with Minnesota Life suing Shurwest, an Arizona independent marketing organization, in July. When Shurwest filed for bankruptcy on Aug. 31, it attracted little notice beyond a single line in a local business journal.

In the weeks that followed, court documents would reveal the IMO’s alleged role in a fraudulent scheme to pump up indexed universal life sales.

The scheme originated with Scott Alan Kohn, who formed Pensions, Annuities, and Settlements in 2011. Prosecutors say his plan was simple: Using various marketing efforts, FIP and Kohn solicited pensioners by offering the ability to receive a lump sum in exchange for a portion of their future pension payments. FIP called the practice “structured cash flows,” and the company used brokers and insurance producers to find investors — often retired veterans, teachers and firefighters.

Unknown to many investors, the future pension payment terms required them to pay what often equated to an annual interest rate exceeding 100% over a five-year term.

The scheme was allegedly adapted to IUL sales by Shurwest agents. Minnesota Life claims the agents altered policy applications on more than 1,000 policies sold through Shurwest between 2014 and 2018. The insurer said 222 of those policies were linked to an investment in FIP.

Shurwest executives claim a rogue manager led agents into the scam without their knowledge. As of early June, Shurwest and various attorneys were attempting to work out an agreement with a court-appointed overseer to compensate victims of the scam.

Motivation to create new products

Indexed life insurance and annuity products are no doubt here to stay. For consumers, the allure of the market, with downside protection and even a zero floor, is just too enticing. And those strong sales numbers mean insurers will remain motivated to create new, some say more complex, product designs.

For agents, the calculus is simple: indexed products deliver good compensation.
History has shown the indexed market is rife with players willing to stretch the boundaries, if not break the rules. That means regulators and litigators will continue to monitor the indexed market as well.

“I remember when I was super gung-ho about indexed products and no one was really talking about them,” Moore recalled. “We had product manufacturers that were pooh-poohing the index insurance products. Some of that had to do with controversy and unsuitable sales and a cowboy mentality that we had going on at the time.

“It’s so funny to me that now we have those same product manufacturers that were bad-mouthing indexed products kind of emulating indexed insurance products.”

InsuranceNewsNet Senior Editor John Hilton has covered business and other beats in more than 20 years of daily journalism. John may be reached at [email protected]. Follow him on Twitter @INNJohnH.