Is Life Insurance Good for Retirement Planning?Published: August 19, 1999 in Knowledge@Wharton
At first glance, the life insurance industry appears to be in trouble as it faces the millennium. As the large baby boomer market ages, these consumers have shifted their financial focus away from life insurance and towards assuring their future comfort. Although the industry has long recognized that its future lies in more in financial products than in life insurance, it has lately been losing its share of the retirement market.
Between 1992 and 1994 alone, insurers' share of 401(k) plans slipped from 34% to 30%, while mutual funds' share leaped from 26% to 37%. Tax-deferred annuities sold by insurance companies fell in share of Americans' total retirement assets to 16.61% in 1996 from its peak in 1990 of 22.56%. In individual retirement accounts, while banks' market share fell dramatically from 61% in 1985 to 18.4% in 1996, insurance companies saw mutual funds and brokerage houses gain the fattest slices of the banks' loss.
Such developments can, however, be misleading. Two experts who believe that the life insurance industry's picture is far brighter than it first appears are Paul Hoffman and Anthony M. Santomero of the Wharton School's Financial Institutions Center. Their paper, "Life Insurance Firms in the Retirement Market: Is the News All Bad?" answers their own titular question with a decided "no." Hoffman and Santomero point to a number of facts that, while not completely reassuring to the industry, definitely show some profitable opportunities. A revised version of this paper appeared in the Journal of the American Society of CLU and ChFC.
First of all, retirement planning is a huge and growing market. Contrary to reports that have appeared in the past, baby boomers are saving more rapidly than their parents. And, face it, they have to: The decline of defined benefit plans, which Americans once counted on so heavily for their golden years, demands that they look to other financial instruments to protect their futures. That opens up new sales opportunities for group and individual retirement plans sold by financial companies, including insurers. And annuities, which are insurers' biggest retirement-oriented product, are growing in importance as a share of Americans' wealth. Moreover, annuities have remained stable as a percentage of retirement assets.
Second, while mutual funds and brokerage houses have been expanding their market share, their inroads have been mostly at the expense of depository institutions, not life insurance companies.
Third, the retirement market is a growing financial feast, even if insurers do have to compete a little harder for their share of the bounty. By the end of 1996, total private retirement assets in the U.S. stood at almost $5.1 trillion, having increased as a share of total national wealth from 10.6% in 1983 to 13.6%.
There has also been a decided shift in the nature of the nation's retirement assets. In 1980, total defined benefit assets in the U.S. were 2.5 times defined contribution assets (mostly, 401(k) plans). By 1993, the latest date for which figures are available, total funds of both types of plans were almost equal. From 1984 to 1993, total U.S. 401(k) assets alone grew from about $92 billion to $616 billion, increasing from 0.74% of Americans' total wealth to 2.18%. As a share of total retirement capital, 401(k)s rose from about 7% in 1984 to 16.6% in 1993, according to the U.S. Department of Labor.
Individual retirement accounts, although no longer as attractive as a saving vehicle due to the loss of most tax advantages in 1986, still capture a huge amount of total retirement assets. By the end of 1996, savings in IRAs had swollen to $1.35 trillion, representing around 3% of U.S. wealth. Most of the growth was from gains in the equity market rather than in new contributions. Meanwhile, mutual funds and brokerage firms picked up more than 43% of the depository institutions' drop in IRA market share, increasing their own share from 15.8% to 37.9% for mutual funds and 14.7% to 35.8% in the case of brokerages. Insurers' share of the IRA market actually fell from 10.4% in 1990 to 7.8% in 1996.
The annuity market represent insurers' best hopes to retain a significant share of the retirement market. In 1993, annuities represented almost 20% of the market, following IRAs' 23.4%. Insurance companies' share of this huge financial stash stood at almost 76% in 1993, equal to more than $1 trillion, of which about $734 billion was earmarked for retirement. (These figures only include tax-advantaged annuities).
Life insurance carriers, then, are likely to retain significant sales and profit growth in the retirement market. Still, the industry needs to find new ways to grow. Its recent binge of mergers and acquisitions has improved cost efficiency and diminished competition among carriers, but is scarcely enough to offset inroads by brokers and mutual funds. Even banks have declared their intentions to market competitive new instruments in the annuities market. A disturbing development for insurance companies is their loss of share of revenue, from 55% of sales fees for variable annuities in 1994 to only 43% the next year. The Wall Street Journal has predicted that insurers' share of these fees could fall to 30% by the year 2000.
With these developments in mind, strategy for life insurance firms in the decade ahead need to aim at stopping their skid out of the retirement market, where they have fallen from a 22.7% market share in 1983 to 18% in 1996. Elements of a successful strategy might include:
1. Retain dominance in annuities by increasing cost efficiency in delivery and holding down fees, to maintain competitiveness with other financial services.
2. Slow down loss of market share for IRA accounts. While this market has diminished in terms of new contributions, financial returns on existing IRA assets have grown to 12% of insurance company pension assets as of 1996, from 3.3% in 1983.
3. Jump with both feet into the exploding 401(k) market, with particular emphasis on pursuing the fat market for rollover accounts.
For the life insurance industry, the stakes are clear. While its decline in competitiveness is not as serious as widely proclaimed, its share of the retirement market has been falling by more than 1% a year in recent years. Because its income from annuities has surpassed its income from life insurance since 1985, clearly it must continue to pursue the retirement segment. Now, however, it also needs to look to ways of solidifying and perhaps expanding its share of the 401(k) and IRA niches.
Insurers' strength is that they can leverage a wide spectrum of products to help them to protect their presence in the retirement marketplace. For example, they can offer one-stop shopping for a combination of retirement income, long-term care coverage and estate protection. By offering consumers products that blend traditional risk protection with asset management, insurers may be able to protect their own future.