2015 Fixed Indexed Annuity Distribution Trends. Marketing, Sales and Sales Support Developments in Third-Party Channels

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July 2015

2015 Fixed Indexed Annuity

Distribution Trends

Marketing, Sales and Sales Support

Developments in Third-Party Channels

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About the Insured Retirement Institute:

The Insured Retirement Institute (IRI) is a not-for-profit organization that for more than twenty years has been a mainstay of service, commitment and collaboration within the insured retirement industry. Today, IRI is considered to be the authoritative source of all things pertaining to annuities, insured retirement strategies and retirement planning. IRI proudly leads a national consumer education coalition of more than thirty organizations and is the only association that represents the entire supply chain of insured retirement strategies: Our members are the major insurers, asset managers, broker-dealers/distributors, and 150,000 financial professionals. IRI exists to vigorously promote consumer confidence in the value and viability of insured retirement strategies, bringing together the interests of the industry, financial advisors and consumers under one umbrella. IRI’s mission is to: encourage industry adherence to highest ethical principles; promote better understanding of the insured retirement value proposition; develop and promote best practice standards to improve value delivery; and advocate before public policymakers on critical issues affecting insured retirement strategies and the consumers that rely on their guarantees. Visit www.IRIonline.org today to experience the vast resources of the Insured Retirement Institute for yourself.

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2015 Fixed Indexed Annuity Distribution Trends | 1

OVERVIEW

Fixed Indexed Annuities (FIAs), are growing rapidly both in terms of sales and in terms of their footprint in third-party distribution. Historically available primarily through captive insurance agencies, the product is now offered through regional, independent, and full-service (wirehouse) broker-dealers. The product has seen double digit percentage growth the past two years, with sales increasing 14% to $38.7 billion in 2013 and another 24% to $48 billion in 2014, or about 21% of all annuity sales. FIAs have also outsold traditional fixed annuities since 2012. Essentially a fixed annuity, but with a crediting rate that is a function of the change in price of one or more indexes, FIAs can be complex and difficult to understand and some distributors have created specific training programs and suitability review processes to ensure that advisors understand what they are selling, and consumers understand what they are buying. From January through March of 2015 IRI conducted a survey of 15 broker-dealers/distributors, across all third-party channels, to form a picture of how the landscape for these products is evolving, and how distributors are managing the rapid growth of FIAs.

KEY OBSERVATIONS

❚ Variable Annuities with Guaranteed Lifetime Withdrawal Benefits are still the market leader, representing almost half of total annuity sales.

❚ While still eclipsed by variable annuities, FIA sales now account for 10% of total broker/dealer annuity sales, versus traditional fixed annuities which account for 7%.

❚ Eight in 10 distributors say their sales of FIAs are growing, and four in 10 say sales are growing significantly.

❚ Half of distributors believe FIAs will make up a greater percentage of their overall annuity sales in the future.

❚ Distributors believe that higher interest rates, lifetime income benefits, and principal protection with some upside potential will be the primary drivers of FIA sales growth.

❚ Nine in 10 distributors make five or more FIAs available to their advisors. ❚ Eight in 10 distributors offer products from five or more insurers.

❚ For almost one-half of survey respondents, more than 50% of fixed indexed sales include a guaranteed lifetime income benefit

❚ About six in 10 distributors believe that wholesalers are very or extremely important to the success of the sales process, and almost eight in 10 believe wholesalers are very or extremely helpful to their advisors.

❚ Eight in 10 distributors allow maximum surrender charges of no more than nine or ten years; fewer than one in 10 allow surrender charges to exceed ten years.

❚ The FIA products sold by more than six in 10 distributors pay gross commission of 5% or less, with the remainder using products that pay 7% or less. No distributor surveyed carries a product paying more than a 7% gross commission.

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FIXED INDEXED ANNUITIES – A PRIMER

While a comprehensive treatment of FIA products is beyond the scope of this paper, a brief introduction to the product is useful for providing background. An FIA is a fixed annuity that credits a minimum guaranteed rate of interest over a fixed number of years, plus additional interest that may be credited based on the percentage change in the value of a broad market index. Interest is calculated using a formula that determines how much of that percentage change applies to the account value of the FIA. Participation rates, caps, and spreads are all tools used to limit the amount of interest that can be credited based on the change in value of the index. For example, if an FIA has a participation rate of 50% of the change in the value of the S&P 500 index, and the index returns 10% in a policy year, 5% is credited to the account. These tools help make the product economically viable, i.e. by limiting upside the insurance company is able to purchase index options with the portion of the premium that is not invested at interest to support the minimum guaranteed interest rate. The lower prevailing interest rates, the less “budget” exists to purchase options on the index from which the additional interest is derived. The first FIA product was called KeyIndex, issued in February, 1995 by Keyport Life Insurance Company, followed by Lincoln Benefit Life’s Savers Index in June of that year, and the product operated much like these simple examples. Since that time FIAs have evolved, with changes both to the formulas used to calculate credited interest and to the indexes themselves, which for some products have moved beyond broad market indexes into synthetic indexes designed to dampen volatility. Additionally, many FIAs now offer Guaranteed Lifetime Withdrawal Benefits, positioning the product as both an accumulation and income solution. This delivers new, innovative solutions for solving complex saving and retirement problems, as well as challenging distributors to provide product support and training.

FIA SALES AND SALES GROWTH

About sixty percent of surveyed firms say that at least 26% of their financial professionals use FIAs in their practices, with about one-third stating that more than 50% use FIA products.

60% of surveyed firms say that annuities make up 10% to 25% of their total product sales.

29%

21%

29%

Percentage of Financial Professionals Using FIAs

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2015 Fixed Indexed Annuity Distribution Trends | 3 Variable annuities with Guaranteed Lifetime Withdrawal Benefits lead the market, capturing 48% of annuity sales, followed closely by variable annuities without Lifetime Withdrawal Benefits at 22% of sales. Fixed Indexed Annuities, however, rank third with 10% of sales. This is a strong showing for a product that many third party distributors did not offer just a few years ago.

20%

60%

20%

Annuities as a Percentage of Total Sales

Less than 10% 10% to 25% 26% to 50%

Sales of Annuity Types as a Percentage of Total Annuity Sales

7% 5% 4% 1% 2% 0.2% 22% 48% 10% 0% 10% 20% 30% 40% 50% 60% Fixed Annuities (SPDA)

Fixed Indexes Annuities (FIA) FIA with Guaranteed Lifetime Income Benefits Single Premiums Immediate Annuities (SPIA) Deferred Income Annuities (DIA) Variable Annuities (VA) WITH Guaranteed Lifetime Income Variable Annuities (VA) WITHOUT Guaranteed Lifetime Structured Variable Annuities Other

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Almost 40% of survey respondents state that their sales of FIAs are growing significantly, with another 40% citing modest growth. This aligns with the significant growth observed in the aggregate industry sales data.

Looking ahead, however, more respondents believe future sales growth will be modest, though almost one-third still expect significant future sales growth.

0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Growing significantly Growing modestly Steady Declining modestly Declining significantly 39% 39% 23% 0% 0%

Current FIA Sales Growth

31% 46% 15% 8% 0% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% Sales will grow significantly

Sales will grow modestly Sales will remain about the same Sales will decline modestly Sales will decline significantly

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2015 Fixed Indexed Annuity Distribution Trends | 5 Respondents were also asked to state the top three factors they expect to drive further growth in FIA sales:

Both higher interest rates and persistent low interest rates were cited as potential sales drivers, which seems paradoxical but in fact is simply viewing the product from two different perspectives. In a persistent low interest rate environment, sales are boosted by the product being an attractive alternative to low interest products such as CDs. As rates rise, index options become less expensive and FIAs are able to provide more upside potential, making the product more attractive from a growth standpoint. The availability of guaranteed lifetime income benefits with FIAs was also noted as a strong growth driver, as evidenced by almost half of respondents reporting that more than 50% of their FIA sales include a lifetime income benefit.

8%

23%

46%

Percentage of FIA Sales with a Lifetime Income Benefit Attached

5% to 10% 11% to 25% 26% to 50% More than 50%

Top Factors

Secondary Factors

Other Factors

Higher interest rates Continued product enhancements Poor product reputation due to early designs fading

FIAs offer lifetime income benefits similar to those offered with variable annuities

Optional income and death benefits Consumer education about longevity risk

Concern that lifetime income benefits may be less generous in the future

Demographics, e.g. aging Baby Boomers

More carriers offering product, improved wholesaling

Value of principal protection with

some upside potential Product benefit education Improving indexing strategies Persistent low interest rates Market correction or bear market _conditions

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In terms of the percentage of future annuity sales, while almost half of respondents expect FIAs to be a bigger part of their annuity business, half expect the ratios to remain about the same. Of note, no respondents expect FIA sales to comprise a lower percentage of their annuity business.

Respondents expecting FIAs to be a larger component of their annuity business in the future largely cited current sales growth trends, de-risking of VA lifetime income benefits, and more competitive product offerings as drivers. Those believing their ratio of annuity sales will remain about the same pointed to the FIA playing a complementary role to a core VA-based business.

Given the similarities between FIAs and other product in terms of the roles they can play in the portfolio, respondents were asked the extent to which FIA sales are displacing sales of other financial products. The top three were variable annuities with lifetime income benefits, traditional fixed annuities, and certificates of deposit, and at least some displacement was noted by many respondents with all types of fixed income products.

46%

54%

0%

0% 10% 20% 30% 40% 50% 60%

Greater percentage than today

About the same as today

Lower percentage than today

Expected Growth in FIA as a Percentage of Total Annuity Sales

Extent to Which FIAs are Displacing Sales of Other Products

Significant Displacement Some Displacement No Displacement Not applicable 0 2 4 6 8 10 12 14 Bond funds Government bonds Corporate bonds Certiﬁcates of Deposit Traditional deferred fixed annuities Variable annuities WITHOUT lifetime income benefits Variable annuities WITH lifetime income benefits

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THE SUPPLY CHAIN

The number of companies offering FIAs has grown in recent years. In 2014, 39 companies reported sales for 323 unique FIA products (Source: Beacon Research). The survey sought to develop an understanding of how this growth is translating into carrier and product availability on broker-dealer platforms.

The majority of survey respondents make the FIAs of five or more insurance companies available to their financial professionals. About one-third of distributors work directly with issuing companies, another third obtain product from an independent marketing organization (IMO), and 39% have direct relationships with issuing companies and also use IMOs. The majority also make five or more FIA products available. This is important to ensure that advisors have choice and flexibility, but also highlights the need for product-specific training to ensure they fully understand product nuances.

0% 21% 79% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 1 or 2 3 or 4 5 or more

Number of FIA Suppliers

31%

39%

Working Directly with Manufacturers versus with

Independent Marketing Organizations (IMOs)

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PRODUCT STRUCTURE

Distributors may decide which types of crediting strategies they will make available to their financial professionals. The most straightforward strategy, annual point-to-point, is offered by every distributor that makes FIAs available to advisors. Other, generally newer, strategies such as daily averaging or inverse point-to-point, are less likely to be made available.

0 2 4 6 8 10 12 14 Annual point-to-point

Inverse annual point-to-point

Monthly point-to-point_{Quarterly point-to-point}

Other period point-to-point

Term end point

Monthly averagingDaily averaging

High water mark featuresFixed with multi-yearFixed with equity kickerMultiple index strategies

FIA Crediting Strategies by Firm Availability

Available for all sales Use evaluated on a case by case basis Permitted but discouraged Not permitted

Not oﬀered in any fixed indexed product we sell

0% 7% 93% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1 or 2 3 or 4 5 or more

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2015 Fixed Indexed Annuity Distribution Trends | 9 Similarly, distributors may evaluate and restrict participation rates, caps, and spreads when selecting FIA products to put on their “shelves.” The majority of firms have a fairly open architecture in this respect, with index-linked interest spreads or asset based fees and “uncapped” strategies being the most likely to be restricted in some way. Of note is that two respondents do not permit participation rates of less than 100%; a possible reason for this may be the challenge of explaining the concept of partial participation in the index gain to consumers.

In past years, a common criticism leveled at FIAs was the payment of excessive compensation to the sellers of the products, which resulted in lengthy and onerous surrender charges, sometimes in excess of 20 years, for the purchasers. This certainly does not seems to be the case with today’s FIA, for which almost two-thirds of distributors report gross commissions of 5% or less, and about 80% report maximum nine or 10 year surrender charge schedules. No respondents reported gross commission in excess of 7%.

FIA Participation Rates, Caps and Spreads by Firm Availability

Available for all sales Use evaluated on a case-by-case basis Permitted but discouraged Not permitted

Not oﬀered in any fixed indexed product we sell 0 2 4 6 8 10 12 14 Participation rates

less than 100% interest cappedIndex-linked interest spread Index-linked (may also be expressed as an asset fee) "Uncapped" strategies (100% participation with allocation requirement to a ﬁxed account and/

or linked to a volatility controlled custom index)

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64% 36% 0% 0% 10% 20% 30% 40% 50% 60% 70% 5% or less 6% or 7% More than 7%

Maximum FIA Up-Front Gross Commission

0%

14%

79%

7%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% Less than 7 years

7 or 8 years 9 or 10 years More than 10 years

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PRODUCT PERCEPTION

Survey respondents say that almost two-thirds of their financial professionals are very receptive to using FIAs without lifetime income benefits, and 43% are very or extremely receptive to using FIAs with Lifetime Income Benefits. With the latter, 50% are only somewhat receptive and will more frequently use other products, such as variable annuities with lifetime withdrawal benefits.

Receptivity of Financial Professionals to FIAs WITH Lifetime Income Beneﬁts

14% 29% 50% 7% 0% 0% 10% 20% 30% 40% 50% 60%

Extremely receptive, they are asking for them and using them widely in their practices Very receptive, they are excited and engaged when

hearing about the product and frequently use it in their practices for clients that need guaranteed income Somewhat receptive, they are open to using the product and/or learning more about it but frequently use other products, such as VA with GLWB, instead Neutral, they haven't seemed to either embrace or reject the product Not at all receptive, they don't understand how it

works, think it is too complicated, and/or are concerned their clients won't understand it

Extremely receptive, they are asking for FIAs and use them widely in their practices Very receptive, they are excited and engaged when hearing about FIAs and frequently use them in their practices as a CD substitute Somewhat receptive, they are open to using FIAs and/or learning more about them but on balance they favor more traditional ﬁxed income products such as CDs Neutral, they haven't seemed to either embrace or reject FIAs Not at all receptive, they don't understand how FIAs, think they are too complicated, and/or are concerned their clients won't understand them

0% 0% 64% 21% 14% 0% 10% 20% 30% 40% 50% 60% 70%

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On balance, distributors feel that safety of principal is the most important aspect of FIAs to consumers, with most rating it an extremely or very important feature. Also of high importance are the FIA as a fixed income “substitute,” i.e. a product that provides a bond-like return without carrying the interest rate risk of a bond, the availability of guaranteed lifetime income benefits, and guaranteed growth.

Like advisors, consumers are receptive to the use of FIAs. While they are not very likely to ask about them, almost 40% of distributors believe their customers are completely open to using them in their portfolios.

Importance of FIA Features to Consumers

Extremely important Very important Somewhat important Neutral Not at all important 0 2 4 6 8 10 12 14 Safety of

principal Guaranteed growth Participation rates less than 100% Participation in market gains Fixed income "substitute" with no interest rate risk Participation rates less than 100% 8% 39% 23% 31% 0% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Extremely receptive (they ask about FIAs and/or are

enthusiastic about using them) Very receptive (they are completely open to using FIAs)

Somewhat receptive (they may have reservations or questions but are cautiously open to learning more) Neutral (they don't dislike FIAs but aren't enthusiastic about them either) Not at all receptive (it takes a lot of patience and overcoming of objections to move a sale forward)

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SALES SUPPORT

The relative “newness” of FIAs to financial professionals creates some challenges for distributors. Inadequate understanding of the products can create suitability and compliance risks, making it critical for distributors to provide training and support. The majority of distributors appear to have a handle on this, with about two-thirds covering FIAs in their broader annuity training and another one-third conducting FIA-specific training. A third of distributors also provide opportunities for continuing education (CE) credit through FIA training.

Only about 20% of distributors have suitability review procedures specific to fixed indexed annuities, but the remaining firms handle suitability review as part of broader annuity sales guidelines or through their general suitability review process.

We do not have a specific training program for fixed indexed annuities. We have some training materials and/or tools but no

guided or classroom training. Fixed indexed annuities are covered in our broader annuity training We conduct dedicated training specifically for fixed indexed annuities. Our fixed indexed annuity training provides opportunities for CE credit. Other 7% 29% 64% 29% 29% 14% 0% 10% 20% 30% 40% 50% 60% 70%

FIA Training

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Distributors lean fairly heavily on product manufacturers for support, particularly when products are complex. About 60% of distributors consider wholesalers to be extremely or very important to the sales process, and three in four find them to be extremely or very helpful.

21%

57%

21%

0% 10% 20% 30% 40% 50% 60% Fixed indexed annuities, as well as other

annuity types, are handled as part of our general suitability review and sale approval process. We have policies and procedures for suitability review and sale approval that cover all annuities (fixed, immediate, variable, and fixed indexed).

We have speciﬁc policies and procedures with regard to suitability review and sale approval of fixed indexed annuities.

FIA Suitability Review and Approval Processes

23% 39% 23% 15% 0% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

Importance of Wholesaler Support to the FIA Sales Process

Extremely important, we rely heavily on wholesalers and may involve them in complex or large cases Very important, our financial professionals and/or

support staﬀ contact wholesalers often to understand how FIAs work and how to explain them Somewhat important, our financial professionals and/or support staﬀ may reach out to wholesalers with questions from time to time Neutral, I don't really have an opinion as to how

important they are Not at all important, our financial professionals and/or support staﬀ do not rely on wholesalers

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2015 Fixed Indexed Annuity Distribution Trends | 15 To the extent that distributors use IMOs, the majority also find them extremely or very helpful.

23% 54% 8% 15% 0% 0% 10% 20% 30% 40% 50% 60% Extremely helpful, we get excellent support and

we would not be successful without it Very helpful, the wholesalers we work with are almost always easily reached and their support helps us close sales Somewhat helpful, though they may sometimes be diﬃcult to reach, lack complete product knowledge, or are occasionally deﬁcient in other them Neutral, I don't really have an opinion about

how helpful they are Not at all helpful, they are diﬃcult to reach, don't know the products as well as they should, or otherwise fall short

Helpfulness of Wholesalers in the FIA Sales Process

56% 22% 0% 11% 11% 0% 10% 20% 30% 40% 50% 60% Extremely helpful, they provide excellent service and

support and we would not be successful without them Very helpful, the IMOs we work with are very engaged, keep us up to date on new products and product developments and provide training Somewhat helpful, we value them but they fall short in one or more areas Neutral, I don't really have an opinion about how helpful they are Not at all helpful, we would do just ﬁne without them

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CONCLUSION

While variable annuities capture the lion’s share of premium dollars in third-party distribution channels, sales of FIAs are growing, reflecting the appeal of the product to both advisors and consumers. They can provide principal protection, some upside potential, and guaranteed lifetime income benefits comparable to those currently available on VA products. Advisors and consumers value these attributes, as evidenced by their receptivity to FIAs, particularly when guaranteed lifetime income benefits are offered. FIAs are evolving fairly rapidly, but distributors seem to be managing this through training, leveraging wholesaler and IMO support, and in some cases limiting the availability of certain types of crediting strategies. Relatively few distributors have set up specific policies and procedures for FIA suitability reviews, but this is not necessarily an area of deficiency as they are covering the product under their general suitability review processes.

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METHODOLOGY

The Insured Retirement Institute (IRI) conducted a survey of 15 IRI member distributor firms between January and March 2015 to measure trends in fixed indexed annuity market development. All third-party channels were represented in the survey.

Distribution Channels of Survey Respondents

13% 13% 40% 7% 27% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% National Wirehouse

Regional Broker Dealer

Independent Broker/Dealer

Bank

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Insured Retirement Institute