Needed: More Pools, Less Hedges

As the deleveraging of the world economy progresses with rapid ferocity, all things equity have been decimated beyond recognition. 401(k)s and mutual funds are back to the levels they were when today's crop of college graduates were in the fifth grade.

Many rules of thumb about equity investing have been blown to smithereens. No longer will we be able to confidently say "Since 1926, equities have averaged 10% per year." It's now in the single digits on the order of 8 or 9%. The definition of "long term" will undoubtably be called into question, as 10 years now appears to be not nearly long enough to ensure positive returns in the markets. As evidence, consider the Dow Jone Industrial Average first hit 10,000 on March 29, 1999, and as I write this stands about 35% BELOW that level, ten years later.

And herein lies the rub - the insurance industry, having launched en masse living benefits in the post 2000-2002 tech bubble to much fanfare, is on the wrong end of a Faustian bargain in which it traded its soul - rooted in mortality pooling - for the much sexier and palatable investment-hedged approach to retirement income guarantees.

That said, all is not lost, though there is much work to be done to rebalance to a healthier, more sustainable product mix. For example, the top six sellers of variable annuities in the financial planner channel in 2008 sold about $30 billion of the product, most of it with a living benefit guarantee. This represents about 75% of variable annuity sales in this channel. Meanwhile, these same leading companies sold all of $190 million in income annuities in this channel. That's a ratio of roughly 160/1, or $160 dollars of variable annuity premium for every $1 dollar of income annuity. At the other end of the spectrum, the top single seller of income annuties in this channel sold 40% more in income annuities than these six top VA sellers combined, and in fact sold less in variable annuities than in income annuities.

Of course, it's fair to assume that many of the VA purchasers weren't yet ready for retirement income and thus wouldn't be income annuity candidates, yet it's also reasonable to assume that far more than 1 out of 160 clients was ready for retirement income and thus would have been income annuity candidates. So here is the irony: the vast majority of clients in the financial planner space do not own an income annuity, at precisely the time in the financial and economic history of this country that they most need this product, and that manufacturers need less VA with guarantees on their books.

Much has been written in financial and academic journals about asset allocation optomization and the stabilizing benefits it provides investors and portfolios. As the insurance industry works to solve the retirement income needs of today's pensionless retirees, a similar optomization exercise needs to be performed at the manufacturer and distributor level to determine the appropriate mix of risk pooled (annuitized) and investment-centric (living benefit) solutions. I am most certainly not the guy to do that, but something tells me 99.5/.5 is not a healthy, sustainable mix.