Variable Annuity Market Trends:Pricing Rational,Sales Outlook Negative;DOL Rule to Shrink VA Market
Our near-term outlook for the VA business is cautious. We expect pricecompetition to remain rational, but forecast sales to be weak. Also, we remainwary of the tail risk posed by living benefit features and project VAs togenerate poor risk-adjusted returns over a full market cycle, especially whenincorporating hedging costs and periodic balance sheet charges. In addition,we expect new DOL fiduciary standards to reduce VA sales by 10-20%.
We expect VA sales to decline 4% in 1Q16 and 2% in 2016. In 4Q15,sales dropped 8% to $30 billion as demand was hurt by a volatile equitymarket and the pullback of selected insurers. TIAA and AXA gained themost share, while Jackson National and Lincoln lost the most. Among ourcoverage companies, we forecast PRU to gain the most share in 2016.Meanwhile, MET’s share is likely to decline significantly given the loss ofthe Fidelity distribution relationship and the sale of the advisor group.
Earnings in insurers’ VA businesses should be weak in 1Q. We forecastVA AUM to be flat in 1Q and to rise 2% in 2016. Thus far in 1Q, the equitymarket is flat. However, on an average daily balance basis, which drivesfees, the market is 5% lower than in 4Q15, implying a drop in fee income.
We expect price competition in the variable annuity market to remainrational. Unlike historical periods following strong market performance, wedo not anticipate an uptick in competition given the exit of several insurers(GNW, HIG, SLF, VOYA, etc.) and the pullback of others.
We remain wary of the tail risk posed by living benefit guarantees.Given current equity market and interest rate levels, we expect net amountsat risk to increase modestly from 12/31/15. We believe that living benefitspresent an ongoing source of tail risk. Severe market corrections, even ifshort-lived, could hurt earnings and capital precisely when insurers’ ratingsare pressured and their access to capital markets is limited (i.e., 2008-2009).Also, most insurers do not reflect hedging costs in operating income, whichoverstates the economic returns of variable annuity blocks.
The DOL’s new fiduciary standards could shrink the VA market. In ourview, the new standards are likely to pressure sales of VAs within qualifiedplans (especially non-guaranteed VAs), result in changes to commissionstructures (and lower the appeal of VAs to distributors), increase compliancecosts, and make it challenging for insurers to offer customer buy-out optionson legacy blocks. The earnings impact should be modest near-term (1-2% ofEPS for most insurers in 2017), but should increase gradually over time.
Our outlook for the life sector remains neutral. Capital flexibility forshare repurchases and rational pricing are key positives. Conversely, weproject the group’s ROE to remain poor and anticipate weak organic growthin most products. Also, we are wary of the impact of sustained low rates andan uptick in credit losses. RGA and PRU remain our top picks. However,RGA seems less compelling given its significant YTD outperformance.