August, 2010

Variable annuity sales over the recent past have been strongly driven by the amount of new business associated with Section 1035 Exchanges. For some carriers, well over half of their new business related to exchanges from competitors' products. Such exchanges could be justified on the basis of new, improved features or cheaper prices compared to the original VA product.

But, the economic crisis has dealt a blow to the number of 1035 Exchanges occurring in the marketplace, and therefore to variable annuity sales in general. Why? The main reason is that older inforce variable annuity contracts with guaranteed living benefits are now "in the money" relative to these guaranteed benefits. Producers have a more difficult time justifying a suitable replacement sale when the existing contract is not only in the money, but also likely permits more flexible asset allocation and is cheaper.

While variable sales have suffered, insurers can at least take heart in the fact that persistency probably has improved as compared to original pricing, and policyholder utilization of the guaranteed living benefits seems to be considerably lower than priced for. This may help take the edge off some of the losses in asset-based fees.

Will life insurers choose to restart 1035 Exchange sales by offering an exchange feature that carries over the dollar amount of living benefit guarantee from the existing contract, subject to certain limits? This could be expensive, but it could also make many more exchanges suitable. Keep watching.

Tim Pfeifer
President