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The Impact of Distribution on the Individual Life and Annuity Industry

The Impact of Distribution on the Individual Life and Annuity Industry
by Marianne Purushotham

Changes in the distribution of life and annuity products continue to create a stir. This article gives you all the main ingredients that have been added to the pot.

Over the past decade or more, changes in the marketing and distribution of individual life and annuity products have strongly impacted industry growth and profitability as well as the design of new product offerings. New distribution channels including banks, broker dealers, wirehouses and the Internet, as well as growth in fee–for–service financial planning, have led to increased opportunity for insurers in terms of access to new customers. However, this has also resulted in increased costs due to more intense regulatory scrutiny and the resulting burden of compliance with new state and federal laws. At the same time, companies also face uncertainty regarding the success and profitability of business sold through newer channels.

Sources Scanned
The primary sources of material for this report include the trade press (National Underwriter, Life Insurance Selling, Broker World, California Broker, Marketing News and Best Review), minutes from LIMRA meetings and conferences, and research reports prepared by LIMRA and various publicly available sources.

Results of Scanning Process
The key issues identified during 2005 include:

  • The continued interest of carriers in the use of third party channels including independent agents, banks, broker dealers, wirehouses, worksite marketers, financial planners and the Internet.
  • The ongoing decline in both the number of affiliated agents and the profitability of affiliated channels.
  • The increased interest in fee–based financial planning and its impact on the distribution of individual life and annuity products.
  • The impact of the Spitzer investigations on commission and sales practices in the United States.
  • Expanded use of technology to improve the efficiency of both distribution channels and the home office issue process.
  • Producer issues related to the growth of the life settlement market.

Distribution Through Third Party Channels
The shift to third party distribution began with both a perceived demand by customers for independence of sales representatives as well as the initial appeal to carriers of the more variable cost structure that third party channels allowed. However, as more companies turned to independent agents and other third party channels, they increasingly found themselves competing for the limited shelf space of third party producers. Competition and commoditization of products have placed significant pressure on profit margins. In addition, independent agents with access to the products of several different carriers can quickly discern and exploit any pricing or design mistakes to the detriment of the individual life writer. And the fact that these producers no longer have a strong affiliation with carriers can impact the quality of business being placed through both persistency and mortality results. More focus will need to be placed on aligning manufacturer and distributor interests to encourage mutually profitable behavior.

In terms of more non–traditional distribution channels including banks, wirehouses and independent financial planners, to date insurers have had more success with selling individual annuities than individual life insurance products. For example, in 2004, stockbrokers and banks wrote approximately 40 percent of total individual annuity new business while less than 10 percent of new individual life premium was written through these channels. Clearly, the transaction–oriented nature of bank products and the investment–oriented nature of wirehouses products make annuities a better fit for distribution through these channels. However, life insurers are currently working to design products and training/service programs that are a better fit for the business environment of wirehouses and bank reps. Examples of this include simplified issue, guaranteed issue and single premium product designs as well as sales training approaches that address the different selling environments.

Decline of the Affiliated Agency System
The affiliated agency system (including career agents, home service agents and multi–line exclusive agents) continues to shrink due to a combination of low recruiting levels and low retention rates. At the end of 2004, LIMRA estimated there were around 160,000 full– time affiliated life agents-down 10 percent from 2001 and down 34 percent from 1989. In addition, the demand for unbiased advice complemented by a wide range of financial products is growing, and by their nature, affiliated channels are ill–equipped to meet these demands.

This issue is not only important to carriers with large affiliated channels, but to the industry as a whole. In today's environment, recruiting inexperienced agents is still critical to the sale of insurance products-especially life insurance products, where despite the growth in non–traditional distribution methods, 90 percent of new premium is sold through affiliated and independent agents. And more than three–quarters of independent agents began their careers as affiliated agents with either a career or multi–line company. If the decline of the affiliated agency system continues and sales through non–traditional channels do not increase significantly, we could be heading for a significant slow down in industry growth.

The Demand for Financial Advice
Financial planning is no longer an area of interest for the affluent market only. Individuals from all income levels are now seeking financial advice from fee–based planners. And financial planners have begun to see the value in teaming with other professionals to provide needed products and services to their clients. Although currently only about one–quarter of independent financial planners indicate that they partner with insurance specialists on a regular basis, this is expected to increase in the future as planners see the value in working with experts from various financial disciplines.

This phenomenon has opened up opportunities for the insurance industry to offer its products and services to new customers as they strive to reduce risk and plan for their future security. However, like other aspects of the financial services industry, financial planning has come under increased regulatory scrutiny in recent years.

In April 2005, the Securities and Exchange Commission adopted a new rule (Rule #202) that clarifies an exemption contained in the Investment Advisors Act of 1940. Under the original 1940 exemption, broker dealers did not have to register under the Act if their advisory services were incidental to brokerage services already being offered to clients and if the broker dealer received no special compensation for advice. However, in 1999, Merrill Lynch and other full service brokers who had been offering fee–based and discount brokerage programs to their clients for many years were granted a further exemption from the Advisors Act by the SEC as long they disclosed to clients that their accounts were brokerage accounts and not advisory accounts.

In 2004, the Financial Planning Association filed suit against the SEC noting that the 1999 exemption contained no clear distinction between advisory services provided by broker dealers and those provided by financial planners. Also, they felt investor protection was weakened due to the fact that brokers were now subject only to suitability guidelines rather than the stronger standard for fiduciary responsibilities.

In response, the SEC issued a new ruling and by Jan. 31, 2006, broker–dealer representatives were required to be in compliance. The new ruling contains all the requirements of the 1999 proposal and in addition, the disclosure to clients was expanded to include notification that there may be differences between the broker dealers' rights and obligations and the client's needs. Also, broker dealers must have an individual on staff and available to clients to discuss these differences.

Commission Disclosure
As a result of the Spitzer investigations, during 2005, several states adopted a version of the NAIC amendment to the Producer Licensing Model Act. That amendment prohibits producers from receiving compensation from an insurer or third party if that producer "receives any compensation from the customer or represents the customer in the placement of insurance" unless they obtain the client's documented acknowledgement of the fact that they will be compensated by a third party and disclose the amount of that compensation to the client.

In addition, the National Association of Secur– ities Dealers (NASD) proposed an expansion of the rules prohibiting non–cash compensation in the sale and distribution of certain securities to cover all security types. NASD also proposed the prohibition of all product–specific cash and non–cash "sales contests." Also, the SEC requested comments on a Point of Sale disclosure form that would "require broker dealers to disclose information regarding the costs and conflicts of interest that arise" from the distribution of investment products including variable life and annuities.

Compliance with new regulations will require considerable time and expense on the part of insurers including possible changes in the way producers are both trained and compensated. It will also inevitably lead to decreased focus on the real business of developing and distributing insurance products. And the costs related to compliance will ultimately impact the price of insurance products.

Technology and Distribution
Carriers are increasingly turning to technology solutions to improve distribution channel performance. This encompasses everything from Web–based functionality for point of sale transactions to jet issue (the use of artificial intelligence approaches to underwrite smaller and less complex cases with minimal human intervention required) and straight through processing of policies. Currently, nine out of 10 producers have the ability to download product forms, illustrations and marketing materials using the Internet; eight in 10 can get information on pending business, client account values and commission information through secure Web sites; and five in 10 use e–signatures and e–applications.

Insurers hope that improvements in technology and the ease of doing business are a step toward increasing sales of insurance through both traditional and non–traditional channels.

The Life Settlement Market
The life settlement market continues to grow and more producers are interested in potential life settlement opportunities.

Many carriers have taken the position that if the settlement of a policy is in the best interest of the client, they are not opposed to producers facilitating the process. However, officially most companies continue to oppose Stranger Owned and/or Investor Owned Life Insurance schemes including non–recourse premium finance deals and have put out notices to their distributors indicating their opposition. (Stranger owned life insurance (SOLI) is the purchase of a life policy for which no insurable interest exists between the insured and the policyowner.) These letters generally state the carrier's intention not to participate in this type of business and alert the producers to changes in application, underwriting and other administrative procedures that will help carriers distinguish "acceptable" sales from "unacceptable" sales. In a few cases, agents have been fired for non–compliance with insurer policies regarding life settlement business.

Several companies have also formed committees made up of representatives from marketing, underwriting, product development and legal areas to regularly examine "suspicious" cases. Suspicious cases include those where there are multiple owners or owners with no relationship to the insured.

Settled policies may not follow patterns of persistency anticipated in product pricing and for lapse–supported products like universal life plans with strong no–lapse guarantees, there is some concern that continued growth of the life settlement market could have an unfavorable impact on profitability.

In addition, continued distortion of the original social benefit that the government has seen in life insurance will eventually lead to increased scrutiny of the tax benefits currently afforded our products.

Both the National Conference of Insurance Legislators (NCOIL) and the National Association of Insurance Commissioners (NAIC) have developed model regulations to help states adopt laws regulating the viatical and life settlement industry. Currently 37 states have some form of viatical legislation and 28 have life settlement laws in place. And in an opinion issued by the Office of the General Council earlier this year, the New York State Insurance Department stated their position that since "no insurable interest exists in connection with certain life premium finance transactions," these transactions would not be permissible under New York insurance law. The opinion goes on to specify those insurance transactions that appear to be entered into only for the purpose of reselling the policies later.

The Need to Continue Scanning
Continued change in the life and annuity distribution arena has the potential to significantly impact the future success of the industry as a whole and makes this an important area for continued monitoring. All the major issues discussed in this document will continue to develop into 2006 and beyond.

Marianne Purushotham is research actuary for LIMRA. She can be contacted at