Annuity Carriers: Innovate Products, Processes, and Technology or Be Left Behind

Transcription

1 Annuity Carriers: Innovate Products, Processes, and Technology or Be Left Behind NOVEMBER 2013 Todd Eyler Photocopying or electronic distribution of this document or any of its contents without prior written consent of the publisher violates U.S. copyright law, and is punishable by statutory damages of up to US$150,000 per infringement, plus attorneys' fees (17 USC 504 et seq.). Without advance permission, illegal copying includes regular photocopying, faxing, excerpting, forwarding electronically, and sharing of online access.

2 TABLE OF CONTENTS IMPACT POINTS... 4 INTRODUCTION... 5 METHODOLOGY... 5 ACCUMULATION-ONLY FOCUS HURTS GROWTH... 6 CONSUMERS WANT GUARANTEED INCOME AND CONTROL OVER ASSETS... 7 COMPLEXITY, COSTS, AND CONFLICTS LIMIT ADVISOR ADOPTION OF ANNUITIES... 8 PRODUCT INNOVATION MORE INVESTMENT CHOICE AND PENSION-LIKE GUARANTEES MOST DISTRIBUTORS SPECIALIZE KEY FOCUS AREAS FOR ANNUITY TECHNOLOGY ELECTRONIC ORDER ENTRY IN-FORCE ANNUITY TRANSACTIONS EXCHANGES A PRIMARY FOCUS IN NON-TOP 10 DISTRIBUTORS FOCUS ON ELECTRONIC ORDER ENTRY ELECTRONIC ORDER ENTRY OPTIONS FOR NON-TOP 10 DISTRIBUTORS NEW RETIREMENT INCOME SOLUTIONS NEEDED TO DRIVE LONG-TERM GROWTH KEY PRODUCT DISRUPTIONS MAXIMIZE FLEXIBILITY, MINIMIZE RISK FROM PRODUCT INNOVATION TO PROCESS INNOVATION RECOMMENDATIONS RELATED AITE GROUP RESEARCH ABOUT AITE GROUP AUTHOR INFORMATION CONTACT LIST OF FIGURES FIGURE 1: ANNUITIES CONSTITUTE LESS THAN 9% OF U.S. RETIREMENT ASSETS... 6 FIGURE 2: INVESTORS ARE ATTRACTED TO GUARANTEED INCOME FOR LIFE, DESPITE LOWER RATE OF RETURN... 7 FIGURE 3: GUARANTEE PRODUCTS RECOMMENDED TO INVESTORS FACING LONGEVITY RISK... 8 FIGURE 4: A MINORITY OF INVESTORS HAVE A FORMAL, WRITTEN RETIREMENT PLAN... 9 FIGURE 5: A SIGNIFICANT MAJORITY OF INVESTORS USE FINANCIAL ADVISORS... 9 FIGURE 6: BROKER-DEALERS INCREASINGLY WANT TO CONTROL INVESTOR ASSETS ON THEIR OWN PLATFORMS FIGURE 7: ANNUITY SALES SHRANK 8% IN FIGURE 8: THE DOMINANT DISTRIBUTION CHANNELS BY ANNUITY PRODUCT TYPE FIGURE 9: THE COMPREHENSIVE 2006 IRI VISION OF ANNUITIES STP FIGURE 10: THE COMPLEXITY OF THE 1035 EXCHANGE PROCESS ALLOWS CEDING CARRIERS TO DELAY IT FIGURE 11: INDEPENDENT ADVISORS OFTEN USE OFF-THE-PLATFORM PRODUCT MANUFACTURERS

3 FIGURE 12: ADVISORS GO OFF-PLATFORM TO AVOID PAYING BROKERAGE PLATFORM FEES FIGURE 13: INSURANCE-AFFILIATED BROKER-DEALERS ADOPT CLEARING-FIRM ACCOUNT OPENING FIGURE 14: CARRIERS ARE IMPROVING STP FOR THEIR AFFILIATED BROKER-DEALERS FIGURE 15: ANNUITY CARRIERS WELL POSITIONED TO PROVIDE THE TAX AND GUARANTEE OVERLAY FOR A WIDE RANGE OF INVESTMENT PRODUCTS FIGURE 16: TECHNOLOGY AND PROCESS COMPONENTS OF AN EFFECTIVE RETIREMENT INCOME SOLUTION LIST OF TABLES TABLE A: PRODUCT USAGE WITHIN INVESTMENT STRATEGIES TABLE B: VARIABLE ANNUITY VS. MUTUAL FUND EXPENSES FOR INVESTORS TABLE C: DTCC ANNUITY TRANSACTION AND REPORTING TYPES TABLE D: A SMALL FRACTION OF DTCC'S DISTRIBUTION FIRMS USE ELECTRONIC ORDER ENTRY TABLE E: REGIONAL BANKS SHOULD BE A NEXT TARGET FOR ELECTRONIC ORDER ENTRY TABLE F: INSURER-AFFILIATED BROKER-DEALERS ARE GOOD TARGETS FOR ELECTRONIC ORDER ENTRY.. 26 TABLE G: ELECTRONIC ORDER ENTRY ALTERNATIVES FOR NON-TOP 10 DISTRIBUTORS TABLE H: LOW-COST VARIABLE ANNUITY AND DEFERRED INCOME ANNUITY FOR INCOME FLOOR

4 IMPACT POINTS This Aite Group report is based on interviews with 10 annuity carriers, including eight of the top 20, and 16 distributors, including 10 to the top 20, between August and October 2013 that sought to understand product, process, and technology gaps and opportunities in the U.S. annuity market. The report also relies on a number of Aite Group financial advisor surveys and a large investor survey. Despite their desire for guaranteed income, the great majority of advisors and investors focus only on asset accumulation, not retirement income. Less than half of investors have a written retirement income plan, and 90% never annuitize the annuities they own. A significant amount of private equity and venture capital has entered the annuity industry to leverage opportunities for product, process, and technology innovation. New product innovations, such as long-term lifetime income guarantees that can activate up to 40 years in the future and variable annuities with hundreds of options that can be used to tailor and tax shelter portfolios to meet investors' particular needs, will reignite annuities market growth after the post-2008 slowdown. To help support and expand growth in annuities sales, annuity carriers should expand beyond electronic order entry for just the top 10 distributors and support electronic order entry capabilities for non-top 10 large banks and affiliated insurance broker-dealers that already extensively use Depository Trust & Clearing Corporation (DTCC) annuity funds transfer and services other than electronic order entry. While the six of the 20 top annuity carriers that have integrated with Ebix's Annuity Maintenance Platform (AMP) have been frustrated with the lack of hard-dollar cost savings, they should view AMP as an important component of overall retirement income solution strategies that can accelerate growth in the use of annuity products. Product innovation in the annuities market will cause disruptive but necessary changes to the ways advisors provide retirement income advice and service. It will require uptake of this advice type and technology solutions that integrate six key components: (1) customer relationship management (CRM) for client data; (2) rigorous retirement income training; (3) consolidated, household-level account views; (4) robust retirement income illustration capabilities that expand existing planning applications; (5) automated funding and implementation capabilities; and (6) performance measurement/monitoring to track progress against the plan. 4

5 INTRODUCTION U.S. annuity carriers enjoy a historic opportunity to expand their market reach and address much more than the 9% of U.S. retirement assets they currently serve. From the late 1990s until 2008, annuity carriers provided income guarantees to baby boomer investors that generated explosive growth of variable annuity products and large investments in electronic order entry applications for processing the high volume of new business. When the market crisis hit in 2008, interest rates remained low, and these guarantees cost annuity carriers billions of dollars, forcing many of the largest carriers to exit the variable annuity market, others to retrench, and the whole industry to suspend straight-through processing (STP) efforts until This Impact Report discusses the current usage of annuities by investors and their advisors as well as the key product, process, and technology challenges for reigniting growth and capturing a much higher share of the total US$20.9 trillion in U.S. retirement assets. The report also provides detailed recommendations about key actions necessary for meeting the challenges and beginning to leverage the very large U.S. retirement income opportunity. The report is written for line-of-business, marketing, product, and technology leaders and managers within annuity carriers. METHODOLOGY Between August and October 2013, Aite Group interviewed 10 U.S. annuity carriers for this report, including eight of the top 20 carriers; 16 U.S. distributors, including 10 of the top 20; as well as a mix of wirehouses, independent broker-dealers, banks, and registered investment advisors (RIAs). This report also references Aite Group survey data from three quantitative financial advisor surveys a March 2012 survey of 248 independent advisors, a March 2012 survey of 515 advisors, and a Q survey of 176 financial advisors. The report is supplemented with qualitative insights derived from interviews with executives of seven leading insurer-affiliated broker-dealers focused on their operational and technology setups. Aite Group interviewed these seven firms in Q and Q in order to evaluate their evolving technology strategies. The seven firms interviewed represent approximately 40% of client assets attributable to the top 15 insurer-affiliated broker-dealers in the United States. The report also references Aite Group survey data from a quantitative survey of 1,041 investors in December The margin of error for the above studies is 4% to 7% at the 95% level of confidence. 5

6 ACCUMULATION-ONLY FOCUS HURTS GROWTH For the past 50 years, the U.S. financial services industry has remained primarily focused on asset accumulation achieved through a narrow set of product and distribution-channel combinations. But following more than 13 years of high volatility in the equity markets, more than six years of very low interest rates, and the realization that people's life spans are often extending into their 90s, U.S. investors hunger for guarantees that they won't outlive their investments. Of the US$20.9 trillion in U.S. total retirement assets as of the end of June 2013, 54% is not subject to any type of a defined-benefit or private insurance guarantee that can allow investors to receive a minimum, floor level of income a "lifetime income" guarantee for as long as they live (Figure 1). Figure 1: Annuities Constitute Less Than 9% of U.S. Retirement Assets $2.6 $2.9 $2.0 $3.1 Source: Investment Company Institute Total U.S. Retirement Assets by Plan Type, 2000 to Q (In US$ trillions) $3.4 $3.6 $3.7 $3.4 $2.3 $2.0 $4.4 $4.0 $2.2 $4.8 $4.9 $4.5 $4.5 $2.5 $2.5 $2.7 $2.8 $3.9 $3.7 $4.2 $4.5 $4.5 $4.9 $5.2 $1.0 $1.4 $1.4 $1.5 $1.7 $1.7 $1.8 $1.8 Ten years ago, a number of large annuity carriers, with CEO-level support, created and funded retirement income solutions groups with mandates to focus on the customer and deliver solutions that effectively combine asset accumulation with annuity instruments that have lifetime income guarantees (both within and often across financial services products and firms). When the financial crisis began in 2008, most annuity carriers disbanded these groups, retrenched, and reverted to their previous product- and channel-only focus. Many others, like The Hartford, ING, John Hancock Financial, and Sun Life Financial, exited their variable annuities businesses entirely after underpricing the lifetime income guarantees within these products. $5.4 $5.0 $5.7 $ Q IRAs Defined contribution plans Private defined benefit plans Government plans Annuity reserves 6

7 CONSUMERS WANT GUARA NTEED INCOME AND CONTROL OVER ASSETS Despite many annuity carriers' current risk aversion, consumers want annuity-type products with guaranteed income attributes. U.S. investor surveys from industry organizations LIMRA and the Insured Retirement Institute, among others, consistently indicate that, with regard to their retirement assets, investors are more focused on the favorable outcome of having enough retirement income for the rest of their lives than on just accumulating assets (Figure 2). A 2013 Allianz Life survey of 1,400 baby boomers between the ages of 55 and 65 finds that 87% of respondents would prefer a financial product that provides a 4% return guaranteed to maintain its value over one that provides an 8% return but is vulnerable to loss. (This survey occurred after the Dow had exceeded 14,000 in early 2013.) 1 And a 2013 Wells Fargo survey of 1,756 middle-class households headed by people between the ages of 25 and 69 finds that 82% want their employers to offer a lifetime income option within their 401(k) and other tax-qualified retirement accounts. 2 Figure 2: Investors Are Attracted to Guaranteed Income for Life, Despite Lower Rate of Return Investors Who Want Guaranteed Income in Retirement, 2011 (By age and wealth bracket, N=44.9 million households) 10.6 Source: Strategic Business Insights, MacroMonitor; Aite Group Under to to Mass market (mid-50%) Affluent (next 15%) Wealthy (top 5%) Allianz Life Insurance Company, Transition Boomers and Retirement Income Survey, April Wells Fargo Retirement Study, p.3. 7

8 Less than half of investors have a formal, written retirement income plan, however (Figure 3). In the absence of formal retirement plans, investors just seek to accumulate as many investment assets as possible. Beyond lacking retirement income plans, investors rarely use annuity product features that allow for guaranteed income. Despite having access to lifetime income guarantees within variable annuity and other annuity products over the past 15 years, less than 10% of investors have converted variable annuity products into lifetime income. Lack of a retirement income plan is an obvious, contributing reason why. Figure 3: Guarantee Products Recommended to Investors Facing Longevity Risk Financial advisors affiliated with an insurance b-d (n=45) Financial advisors with an independent b-d (n=91) Financial advisors with an independent RIA (n=65) Total (n=201) Source: Aite Group survey of 1,041 investors, December 2011 Q. Do you recommend income guarantees to pre-retirees facing longevity risk? 20% COMPLEXITY, COSTS, AND CONF LICTS LIMIT ADVISOR ADOPTION OF ANNUITIES 31% 35% With the exception of RIAs, a majority of independent financial advisors indicate that they want to provide guaranteed income solutions to their customers (Figure 4). Given the complexity of determining particular asset accumulation and retirement income needs and solutions, financial advisors are critical to helping investors with their financial decision-making. More than half of investors have at least one advisor (Figure 5), but for investors and advisors overall, annuities currently play only a minor role within their investment strategies, and those that do use annuities focus primarily on asset accumulation not guaranteed income (Table A). 51% 49% 65% 69% Percentage outlined by square differs significantly from that outlined by circle 80% No Yes 8

9 Figure 4: A Minority of Investors Have a Formal, Written Retirement Plan Investors Who Have Formal, Written Retirement Income Plans, 2011 (By age bracket) 10% 10% 7% 6% 8% 46% 47% 54% 44% 43% 39% 21 to 31 (n=116) Source: Aite Group survey of 248 independent advisors, March 2012 Figure 5: A Significant Majority of Investors Use Financial Advisors 37% 59% 21 to 31 (n=116) 32 to 46 (n=136) 40% 55% 47 to 57 (n=56) Source: Aite Group survey of 1,014 investors, December % 61% 33% 58 to 65 (n=64) 4% 4% 7% 32 to 46 (n=136) Financial Advisor Usage, 2011 (By age bracket) 46% 46% 65+ (n=52) 27% 27% Not sure No Yes 61% 63% 63% 47 to 57 (n=56) 58 to 65 (n=64) No advisor One advisor More than one advisor 11% 10% 65+ (n=52) 9

10 Table A: Product Usage Within Investment Strategies Product usage Pre-retirees more than 10 Pre-retirees 10 years or Retirees years from retirement less from retirement Mutual funds 55% 56% 73% ETFs 17% 15% 16% Stocks 63% 52% 71% Bonds 41% 34% 43% Fixed annuities 19% 23% 30% Variable annuities 12% 14% 26% Options 8% 8% 7% Futures 8% 9% 3% Foreign exchange contracts 6% 6% 2% Commodities 16% 12% 7% Hedge funds/private offerings 8% 5% 4% Gold Investments 13% 13% 11% Physical gold 12% 10% 10% Real estate investment trusts (REITs) 8% 12% 19% Limited partnerships 7% 6% 7% Permanent life insurance 20% 16% 33% Long-term care insurance 13% 16% 21% Source: Aite Group survey of 1,014 U.S. investors, December 2011 To better serve their customers and simplify their operating environments, registered representatives that work for broker-dealers tend to consolidate financial products onto their brokerage platforms, and RIAs tend to maintain control of their customers' investment assets (Figure 6). But the vast majority of annuity products are not integrated into broker-dealer platforms, and very few allow for full custody and control of the assets by the advisor. Our interviews of 16 broker-dealer and RIA firms also suggest that most advisors strongly resist converting assets into income where doing so will make them permanently lose control of the assets and the associated fees. 10

11 Figure 6: Broker-Dealers Increasingly Want to Control Investor Assets on Their Own Platforms Q. Roughly what percentage of your practice s client assets is invested across each type of platform? Fully disclosed insureraffiliated b-d (n=41) 29% 53% 13% 5% Fully disclosed independent b-d (n=75) Self-clearing independent b-d (n=42) 43% Source: Aite Group survey of 176 financial advisors, Q % Beyond advisor concerns about losing control of investor assets, annuity products also create compliance headaches that many advisors want to avoid particularly if they don't work for a top 20 broker-dealer that has advanced operational and compliance capabilities. A 2012 Insured Retirement Institute (IRI) study found that the average financial advisor spends 55.5 hours on state or federal-mandated product training, continuing education, and renewing licenses annually compared to 46.8 hours per year for all other types of investment products combined. 3 Even once an advisor is licensed, state-specific forms and training requirements significantly complicate the ability to sell annuity products to new or existing customers, extending turnaround times on new product sales and undermining the credibility of the advisor who is trying to sell these products. Completing annuity sales takes time. The majority of annuity sales are variable annuity sales, and the majority of these sales are 1035 tax exchanges of one product for another product on behalf of the same customer. Such transactions average six weeks to complete, longer even than the typical mortgage origination, largely because of insurer and state-specific form requirements. The length of the process and how it can undermine credibility with clients often turns off advisors, who then often seek to use simpler investment products instead. Even with significant progress toward electronic order entry for annuities over the past five years (that should also streamline the 1035 exchange process), 1035 exchanges remain an obstacle to increased sales of annuity products. 36% 16% 20% 18% Brokerage platforms Direct business Corporate or independent RIA Other Statistical tests of significance were conducted at the 95% level of confidence 5% 3. Institute for Retirement Income, March 2013: Broker-Dealers, Financial Advisors, and Clients: Annuities and the Regulatory Environment. 11

12 The overall cost of existing annuity products presents another significant hurdle to increased sales. While income tax deferral and guaranteed income guarantees are undoubtedly valuable, when combined with other expenses, they cost the investor an average 2.30% per year. This compares to 0.13% for index mutual funds that are completely focused on asset accumulation (Table B). In addition to higher ongoing expenses, variable annuities usually subject investors to high surrender costs used to help ensure that life and annuity insurers earn back the commissions paid to financial advisors. A typical surrender charge starts at 7% in the first year and then declines 1% per year until it disappears after five to seven years. 4 Table B: Variable Annuity vs. Mutual Fund Expenses for Investors Fees (% of assets) Variable annuities Actively managed equity mutual funds Actively managed bond mutual funds Mortality, living benefits 1.16% Insurer administration 0.31% Underlying funds 0.95% 0.92% 0.65% 0.13% Total 2.42% 0.92% 0.65% 0.13% Source: Morningstar Q for variable annuities, Investment Company Institute 2012 for the mutual funds types Index mutual funds PRODUCT INNOVATION MORE INVESTMENT CHOI CE AND PENSION -LIKE GUARANTEES Innovative annuity carriers have begun to provide what investors and advisors want lower-cost variable annuity alternatives that provide a wider range of tax-deferred investment choices and deferred income annuities that provide a floor level of income through defined pension-like income guarantees. V A R I A B L E A N N U I T I E S Variable annuities, discussed above, provide tax-deferred growth for mutual fund or other underlying investments. They constitute about two-thirds of overall annuity sales over the past 10 years (Figure 7). From the late 1990s until the financial crisis in 2008, product innovation with variable annuities focused on providing lifetime income guarantees within these products for baby boomer customers. Volatile equity markets and very low interest rates since 2008, however, financially exposed the companies that underpriced these guarantees, forcing a number of them to exit variable annuities businesses completely, and others, like Met Life Inc. and Prudential Financial Inc., to significantly reduce their capacity for new sales. 4. Moshe A. Milevsky and Research Institute of CFA Institute, June 2013: Lifetime Income: An Optimal Product For Retirement Income. 12

13 Figure 7: Annuity Sales Shrank 8% in 2012 U.S. Individual Annuity Sales, 2002 to 2012 (In US$ billions) Source: LIMRA $117 $103 With very low interest rates, the cost of hedging lifetime income guarantees has doubled over the past five years, according to Milliman and Robertson, forcing annuity carriers to scale back the level of guarantees and restricting the amount of equity and overall investment risk that investors and advisors can take within these products. 5 Said one advisor interviewed for this report, "For the first time in memory, the current generation of variable annuity products is inferior to prior generations. This is not what advisors and wholesalers have been trained to expect." F I X E D A N N U I T I E S $129 $133 $137 $160 $184 $89 $88 $80 $78 $73 $109 $111 $81 $81 $72 Fixed annuities make up the other one-third of overall annuity sales and also serve primarily as accumulation products. Indexed fixed annuity products provide tax-deferred growth with fixed or banded rates that guarantee a floor level of return in exchange for limiting and sharing upside returns. In the current low-interest-rate, volatile equity market environment, these products are attractive and, at US$34 billion in 2012 sales, have been the fastest-growing type of annuity product since the financial crisis. Less than 10% of either variable or fixed annuity products are ever annuitized, despite investors' ability to do so. Ninety percent or more of the time they are cashed out, surrendered, or exchanged for other annuities. 6 $156 $128 $140 $158 $ Variable Fixed 5. The Milliman Guarantee Index and the Milliman Hedge Cost Index. 6. Moshe A. Milevsky and Research Institute of CFA Institute, June 2013: Lifetime Income: An Optimal Product for Retirement Income. 13

14 I M P O R T A N T, R E C E N T P R O D U C T I N N O V A T I O N S Two unique product differentiators that annuity carriers can provide to investors are (1) income and capital gains tax deferral, and (2) lifetime income guarantees that can kick in up to 40 years in the future. The two innovations provide: Efficient tax deferral for a wide range of assets: The extreme example is Jefferson National, which avoids commissions and surrender fees by focusing on the RIA market, requires ongoing expenses of only a flat US$20 per month, and now includes more than 400 subaccount options for investors. The investment options include non-traditional, tax-inefficient investment vehicles like REITs, managed futures funds, and even hedge funds. Approaches like Jefferson National's provide tax-sheltered platforms for active trading by advisors or whatever investment strategies advisors prefer. Efficient, long-term, lifetime income guarantees: By (1) locking in the exact date, often decades in the future, when the investor will activate the guaranteed income, and (2) requiring no equity exposure, annuity carriers can hedge these guarantees much more safely and less expensively while addressing investors' biggest fear running out of assets 30 or more years into their retirements. Since their downside is protected, having a true, floor-level, long-term income guarantee like this also supports the ability of advisors and investors to take more investment risk to accumulate assets. Aite Group expects the above two product approaches to grow and complement each other over the long term to meet investors' retirement income needs. Both investors and advisors want to maintain control over the assets to focus on accumulation and meet other needs such as being able to pass assets on to their heirs. The guarantee is relatively inexpensive because the insurance company has multiple decades to invest the money and generate profits. Aite Group expects two kinds of annuity carriers, in particular, to grow over the long term: Companies with the highest credit ratings that can provide long-term, permanent income guarantees: Companies with the highest creditworthiness, including New York Life Insurance Company, Northwestern Mutual, Guardian Life Insurance Company of America, Lincoln Financial Group, and TIAA-CREF, have great opportunity in this area. Investors will only accept multi-decade, guaranteed income guarantees from annuity carriers with the highest creditworthiness. Companies that offer the tax-deferred versions of investment supermarkets for advisors and investors, such as Schwab, Fidelity, and Vanguard for mutual funds, where advisors can tailor portfolios to particular investor needs and not just make high-level subaccount changes. The early leader in this area is Jefferson National. To compete here, annuity carriers will need to become technology companies that provide tax-deferred investment and trading platforms to advisors, with similar rebalancing, block trading, performance measurement, multitiered account access, and integration with third-party turnkey asset management platforms. 14

15 Large, creditworthy, technologically sophisticated annuity carriers are well positioned to provide the tax deferral and lifetime income guarantees that all types of retirement assets need (other than the 54% of private and government-defined-benefit plans). Sophisticated advisors will seek to tax shelter investor assets that are not in IRAs or qualified retirement accounts and expand their use of alternative assets like tax-inefficient REITs and commodities. To broaden their opportunity in the annuities market and gain a higher share of overall retirement assets, carriers with large 401(k) and defined contribution businesses will integrate their retail annuities businesses with these businesses to maximize the opportunities for their annuities products. MOST D ISTRIBUTORS SPECIALIZE Independent broker-dealers, wirehouses, and career agents distribute the majority of variable annuity products. Independent agents dominate the distribution of index annuities, but banks are a fast-growing distribution channel for this product. Banks are also the largest distributors of fixed deferred annuity products, since these are a tax-deferred complement to their core CD products. All major distribution channels sell at least some portion of fixed immediate income annuities, showing the potential for broader use of lifetime income products (Figure 8). Market data from LIMRA and our interviews indicate that sales of index annuities through banks are very strong. Both banks and broker-dealers, however, remain somewhat wary of these products from a compliance perspective, since individual states technically administer the regulation for these products. The products do contain clear variable investment features, however, and FINRA has attempted to regulate these products after high-profile sales abuses by advisors. Career agents and banks make the broadest overall use of annuity products of any type of advisor, making them particularly attractive potential adopters of new kinds of guarantee-oriented products. 15

16 Figure 8: The Dominant Distribution Channels by Annuity Product Type Variable Annuities Index Annuities Source: LIMRA Banks 12% Career agents 25% Wirehouses 9% Independent agents 18% Other 13% Wirehouses 17% Fixed Deferred Annuities Other 9% Banks 30% Independ ent b-d 33% Career agents 34% Banks 9% Other 9% Fixed Immediate Annuities Independent b-d 8% Banks 15% Independent agents 19% Other 4% Wirehouses 22% Independent agents 82% Career agents 32% 16

17 KEY FOCUS AREAS FOR ANNUITY TECHNOLOGY The 20 annuity carriers and top 10 broker-dealers and banks have gained significant benefits from electronic order entry initiatives over the past five years. Annuity carriers remain mostly focused on the largest distributors, currently with 1035 exchange process improvements. But carriers should extend electronic order entry capabilities to other banks, other independent broker-dealers as well as insurer-affiliated broker-dealers, and insurance agents to gain similar operational and compliance benefits for the next 60% of annuity sales volume. ELECTRONIC ORDER ENT RY Many of the 20 largest annuity carriers have spent multiple millions of dollars over the past three to five years on two primary types of annuity technology initiatives: (1) electronic order entry for annuities from top 10 broker-dealers, and more recently (2) integration with the largest electronic order entry vendor, Ebix, to streamline after-the-sale, maintenance transactions. The electronic order entry initiatives have largely succeeded, with not-in-good-order (NIGO) rates falling below 20% for variable and other types of annuities products driving significant reductions in turnaround times for new business transactions and significant cost savings for the largest insurers. Each avoided NIGO annuity incident saves US$250 to US$300, on average, in processing costs, equating to millions of dollars in yearly savings for the large writers of variable and other annuity products. 7 The 2006, initial vision for annuities STP for new business, articulated and led by IRI, was comprehensive and focused on the top 10 broker-dealers and banks for a highly integrated, automated process. This vision did not reflect the requirements of non-top 10 distributor brokerdealers, banks, and insurance agents that generate 60% of annuity sales (Figure 9). Smaller distributors now provide the largest opportunity for carriers to further reduce NIGO costs while also reducing their compliance risks. 7. IRI Straight-Through Processing Initiative Update, February

18 Figure 9: The Comprehensive 2006 IRI Vision of Annuities STP Source: Institute of Retirement Income/National Association of Variable Annuities The financial crisis continues for annuity carriers, which rely on normal levels of sales growth and interest margins to fund new technology, product, sales, marketing, and service initiatives. While the top 20 annuity carriers continued with the electronic order entry initiatives from 2008 to 2011 because the of the hard business case associated with the reduced NIGO rates, they retreated from other major annuity STP initiatives until IN-FORCE ANNUITY TRANSA CTIONS Starting in 2009, Ebix invested tens of millions of dollars of its own and its carrier clients' capital to build and integrate carriers and distributors with its AMP. AMP is a utility for streamlining ongoing annuity transactions, using business rules to automate distributor status notifications to carriers and then to customers for ongoing transactions like withdrawals, fund transfers, and subaccount changes. Since 2011, six of the largest carriers have integrated with and gone into production with AMP. Another seven or eight have also invested millions of dollars but currently remain in testing mode only. 18

19 The following important transaction types are on the roadmap to be included within AMP, with withdrawal transactions being the initial areas of focus to date: Partial withdrawals Systematic withdrawals Fund transfers Asset allocation Rebalancing Sub-account changes Account number changes Dollar cost averaging Death notifications Custodial transactions Most of the shorter-term business benefits will go to distributors from AMP, with increased visibility and control over investors' post-sale activities. Unfortunately, annuity carriers built their business cases mostly around reducing post-issue servicing costs, and the six carriers in production with AMP have not come close to realizing the expected cost savings, putting the other seven or eight that have already significantly integrated with AMP in wait-and-see mode. From 2011 to 2013, struggles with AMP have significantly stalled industry-wide efforts to make progress on other, industry-wide annuity STP initiatives EXCHANGES A PRI MARY FOCUS IN 2014 Starting in 2013, IRI has invested time and resources to re-energize industry-wide annuity STP efforts. Its primary members, the top 20 annuity distributors and the top 20 annuity carriers, have focused on the 1035 exchange process. These exchanges are tax-free exchanges through which an advisor replaces one annuity contract for another annuity contract. These transactions comprise a majority of annuity new-business transactions, but the most difficult part of the process, the time-consuming, cross-firm work flows associated with agreeing that all the necessary forms are signed and in good order, falls outside of the current capabilities of the current electronic order entry system alternatives Ebix, Aplify, ipipeline, and Insurance Technologies. To avoid the need for multimillion dollar, "build it and they will come" technology projects, the IRI working groups have focused on incremental process and technology improvements that can generate measurable business benefits for carriers and distributors in the short term and that can build on each other. This follows the historical pattern over the past 15 years where DTCC in particular has driven significant efficiencies for tactical types of reporting and monetary transactions, most with wide industry adoption, for annuity carriers and distributors in general (Table C). 19

20 Table C: DTCC Annuity Transaction and Reporting Types Number of live distributors New business Commission processing Subset of inforce transactions Licensing and appointment routing Asset pricing Financial activity reporting Positions and valuations Number of live carriers Source: DTCC "Active Distributors and Carriers Report" DTCC built a Replacement Processing Service in 2007 designed to supplement electronic order entry platforms and orchestrate the electronic request for exchange and ceding of funds, facilitate the routing of forms, and provide pending-case status messaging to automate the 1035 exchange process. Though the service was ready to deploy to a significant group of committed carriers in 2008, market volatility significantly impacted the business case for carriers to build and implement. Replacement activity came to an abrupt halt because most insurers either raised prices or cut benefits for new sales, making it unattractive, even unsuitable, for those currently invested to replace their contracts. With significantly lower replacement volume, carriers redirected budget and resources to alternative projects particularly AMP. While DTCC s Replacement service remains production-ready, high integration costs for the service make it a longer-term goal for most annuity carriers. Instead of trying to automate the existing 1035 process and completely integrate with DTCC's Replacement Processing Service, the top 20 distributors and top 20 annuity carriers want to prioritize components of the 1035 process and then incrementally generate business benefits and momentum. The IRI working groups have identified 97 pain points and 25 best practices related to the 1035 exchange process to prioritize for coordinated action. Figure 10 gives a view of particular aspects of this error-prone, time-consuming, expensive process. Figure 10: The Complexity of the 1035 Exchange Process Allows Ceding Carriers to Delay It Form types: Replacement, policy summary, exchange, surrender, assignment, authorization with state, carrier, and product-specific versions of the above. Format and signature types: Original copy, faxed copy, electronic PDF copy, original signature, faxed signature, e- signature, carrier-specific authentication requirements. Communication types: Forms submission by regular mail, , fax, or using scan/attach routing from the DTCC; status inquiries; frequent disagreements about whether forms are in good order. Source: ACORD, Cooperative Technologies, Aite Group 20

21 F O R M S / A T T A C H M E N T A N D S E T T L E M E N T I N I T I A T I V E The single biggest reason for the inefficiency of the 1035 exchange process is the vast array of product, carrier, and state-specific PDF forms that must be accessed, printed, forwarded to the correct people among the distributor, ceding carrier, issuing carrier, and customer with original paper copies, and then usually signed with wet signatures. Carriers must distribute, update, and access forms from five places: as paper documents, on any internal advisor portals that they maintain, and on the three most widely used electronic order submission platforms Ebix, Aplify, and ipipeline. DTCC's Replacement Processing Service includes embedded functionality that supports money transfer and the transfer of scanned forms. DTCC also provides this functionality as a stand-alone service. Attachment facilitates the routing of scanned forms and electronic signatures, and Settlement facilitates the communication of payment data and settles funds from one party to another. Carriers do not widely use this service for 1035 exchanges but should. Most carriers also do not use ACORD s 951 transfer of asset form but should. Offered since 2006, the ACORD 961 form provides a standard, electronic form for the issuing and ceding carriers to exchange key contact, policy, disclosure, and other information related to the surrender of the product. Our interviews with 10 carriers that are among the largest writers of annuity products make it clear that few carriers and distributors have so far adopted the 951 form. At the end of October 2013, ACORD provided an updated, more streamlined version of the form (four pages rather than five), that supports both life and annuity products and has removed certain disclosure types. ACORD will also soon update its state-specific 759 form to better clarify state-specific replacement requirements, where there has been significant confusion. It is critical to reduce the number of questions and specific forms, but this will likely take more years of effort to achieve. The following four focus areas can provide immediate benefits: Carriers agree on when the customer needs to be contacted. To avoid having to call the customer multiple times and slow down the process, the top 20 carriers should agree on a contact approach that allows for status checking without multiple customer approvals. Carriers define "in good order." The current lack of clarity here often results in multiple unnecessary rounds of forms exchanges among the ceding and issuing carrier, the customer, and the distributor. Distributors integrate your order entry applications with the Cooperative Technologies Web service, which provides updated, carrier-specific forms requirements and contact information. Notifying the ceding carrier immediately will remove a week or so from the overall process. Carriers and distributors use DTCC's Attachment service for 1035 document exchanges. Many carriers and distributors use the Attachment service but not for 1035 exchanges. Using the Attachment service is more time- and cost-effective than regular mail. 21

22 E - S I G N A T U R E I N I T I A T I V E A couple of large distributors successfully launched e-signature initiatives over the past couple years, but market-wide e-signature adoption for annuities new business remains limited and, for replacements, nonexistent. Our interviews with 16 distributors indicate that they want to adopt an enterprise solution approach for e-signatures that includes not only annuities but also distributors' other financial products; however, most distributors have not yet made these enterprise decisions. Fitting e-signatures into the unique ways that advisors sell products presents another key challenge. Many advisors do not want to require another step in the sales process during which customers must review the application and other forms on their own and then e-sign on their own. Advisors prefer an approach that allows the advisor and customer to meet together in one place, review the documents, and then allow the customer to e-sign the documents using a mobile device such as an ipad, either in the presence of the advisor or on their own. For 1035 exchanges, the use of e-signatures remains non-existent because of overall process complexities. Annuity carrier legal departments still mostly require original forms and wet signatures. Even if there were standard electronic forms like ACORD's 951 and 759 forms, however, annuity carriers require a certification standard that certifies the validity of particular e-signature vendor's solutions. The IRI standard developed in 2006 focuses on back-end security standards but does not yet provide standards for updated, front-end e-signature processes. (For example, the prior certification standard focused on a use case of customers receiving an , verifying that they are who they say they are via the necessary identifiers, then accepting the signature.) Our interviews with carriers and distributors make it clear that they want certification for updated, front-end processes like the in-person ipad scenario described above. Multiple vendor solutions can be used with updated, current e-signature standards for front- and back-end processes so long as they have passed the IRI certification. A certified, vendor-neutral approach for e-signatures should also facilitate their increased use within the 1035 process, but this depends on top 20 annuity carriers' ability to first reduce the number of questions and agree to use standardized forms. Instead of focusing significant time in 2014 on e-signatures beyond the IRI certification initiative, carriers should instead focus on the following: Receive money back from ceding carrier in as little as one day. All of the top 20 carriers support DTCC money settlement processing services today. Use DTCC's transaction-level money settlement service instead of the traditional Automated Clearing House (ACH) or wire transfer options to accelerate money settlement. Simplify the 1035 exchange process as much as possible before making large investments in e-signature technologies. Do not automate and perpetuate a broken process. Jointly pilot CIC's isign Exchange service or other third-party, 1035 work-flow services that come to market. Using cross-firm work-flow services that provide visibility and cross-firm metrics for when forms are exchanged and in good order (or not) will help with 1035 process-simplification efforts. Do not be concerned initially 22

23 about the fact that this application requires the sole, integrated use of CIC's e- signature solution just experiment with using e-signatures within the 1035 process to learn what does and doesn't work. Adopting DTCC's Attachment/forms routing services and Settlement service could, by itself, shave two weeks from the process. If carriers and distributors can significantly reduce process turnaround times through process improvements, status messaging will become much less important and carriers may be able to avoid longterm integration investments in DTCC's Replacement Service. NON-TOP 10 D ISTRIB UTORS FOCUS ON ELECTR ONIC ORDER ENTRY Non-top 10 distributors generate 60% of annuity new sales. To accelerate the solid progress to date with reducing US$250 to US$300 in per-case costs by having clean submissions from distributors using electronic order entry, carriers need to address the next 88% of distributors, which include hundreds of non-top 10 banks, non-top 10 independent broker-dealers, and thousands of independent and career insurance agents. Of these non-top 10 annuity distributors, 200 currently use commission processing, positions and valuation, and money settlement services from DTCC but not electronic order entry (Table D). A subset of these distributors should be the next targets for electronic order entry to drive down NIGO costs and improve regulatory compliance and customer turnaround times. Table D: A Small Fraction of DTCC's Distribution Firms Use Electronic Order Entry Number of live distributors % of total distributor customers New business processing Commission processing Subset of inforce transactions Licensing and appointment routing Asset pricing Financial activity Reporting % 75% 15% 25% 40% 62%` 77% Source: DTCC "Active Distributors and Carriers Report," 213 total distributor customers using annuity services Positions and valuations 23

24 Aite Group's interviews with 16 distributors show that many of the 10th to 20th largest brokerdealer distributors of annuities have made significant progress with new account opening capabilities a good building block enabling electronic order entry for annuities. To make progress with STP for non-top 10 distributors, annuity carriers and distributors should focus on six basic steps and integration points that comprise a subset of the comprehensive vision shown in Figure 9: 1. Account opening: Customer logs in, authenticates, consents to e-delivery 2. Product presentation: Suitable products are shown to customer 3. Selection and order entry: Producer enters order into order entry system 4. Application process: Producer collects all information and forms needed to assure that the application is "in good order" (IGO) 5. Principal suitability review: Automated or in-person review of application to ensure that the selected product is suitable for the customer; this process is managed by the distributor 6. Insurer application: The annuity application package is sent from the distributor to the carrier using DTCC's Applications & Premium (APP) service; funds are transferred from distributor to carrier This process works particularly well when an existing advisor customer buys an annuity and maintains a brokerage account from which to fund it. Things become more complicated when an advisor must open a new account. New account opening, not just for annuities but in general, remains a challenge for non-top 10 distributors, although our interviews with 16 distributors indicate significant progress for the 10th to 20th largest distributors of annuities over the past three years. A key challenge with advisors at non-top 10 distributors is that they often set up one-off, off-thebrokerage platform relationships with annuity carriers and mutual funds (Figure 11). Because independent advisors want maximum flexibility for which product manufacturers they use, they rely on traditional, "check and app" processing for submitting new annuities business. Beyond their increased flexibility with product manufacturer selection, independent advisors also want to avoid paying fees when using electronic order entry applications for annuities or other brokerage platform-specific capabilities (Figure 12). 24

25 Figure 11: Independent Advisors Often Use Off-the-Platform Product Manufacturers Q. Roughly what percentage of your practice's client assets is invested on product manufacturers' platforms (commission-based business off the platform)? Avg. Across fully disclosed segments (N=190) 15% 24% 8% 13% 12% 34% FA with insurance-affiliated b-d (n=55) FA with independent b-d (n=89) FA with bank-affiliated b-d (n=46) Source: Aite Group, survey of 515 U.S. financial advisors, March 2012 Figure 12: Advisors Go Off-Platform to Avoid Paying Brokerage Platform Fees 11% 7% 22% Source: Aite Group survey of 515 U.S. financial advisors, March % 30% 15% 25% 11% 20% 10% 11% 11% 15% 1% to 20% 21% to 40% 41% to 50% 51% to 80% More than 80% Q. What are the benefits of conducting business directly with the product manufacturer? Reduced account maintenance fees Enhanced support for advisors Enhanced support for clients Lower ticket fees 21% 19% 18% 28% 34% 31% 31% 44% 41% 31% 31% Fully disclosed b-d advisors (n=208) Self-clearing b-d advisors (n=72) The top 10 distributors currently exert much more control over what carriers their advisors use and how they transact with them (electronically on their brokerage platforms). Our research finds that midsize banks and independent broker-dealers (distributors in the top 30 overall for annuities distribution) are very concerned about annuities-related compliance risks, a key driver for the adoption of electronic order entry. 25

26 Large regional banks, like those mentioned in Table E, should be prime targets for expanding electronic order entry. They sell a wide range of annuity products and exert control over the products their advisors use and how they transact new business for those products. Many have existing relationships in place with DTCC for commission processing, money settlement, and reporting functions but not yet for DTTC's applications service for electronic order entry. Table E: Regional Banks Should Be a Next Target for Electronic Order Entry Regional bank Fifth Third Bancorp First Citizens Huntington Bancshares Keycorp M&T Bank SunTrust Number of DTCC annuity services used 2 services used, 3 in testing including application 5 services used, 2 in testing, not application 7 services used, but not application 1 service used Source: "DTCC Active Distributors" from DTCC website 3 services used, 1 in testing, not application 3 services used, 2 in testing, not application The independent broker-dealers of large annuity carriers should also be prime targets for order entry through third-party, electronic order entry platforms. They are among the largest distributors of annuity products but often remain tied to manual processes for submitting new business. These firms should enable electronic order entry for their career agents, affiliated broker-dealers, and third-party distributors. Ebix is already available through both NFS and Pershing (the latter clears for all but two of the 20 insurance broker-dealers listed in Table F). Table F: Insurer-Affiliated Broker-Dealers Are Good Targets for Electronic Order Entry Broker-dealer Parent firm # of advisors (Rounded to the nearest hundred) DTCC annuity services used MetLife Securities MetLife Inc. 4,900 5, not application Northwestern Mutual AXA Advisors The Northwestern Mutual Life Insurance Co. AXA Equitable Life Insurance Company 5,900 2, not application 5,200 Not listed LPL Clearing firm affiliation(s) Pershing Pershing MML Investors Services National Planning Corp. Massachusetts Mutual Life Insurance Co. Jackson National Life Insurance Company 4,600 Not listed NFS 1,500 Not listed Pershing 26

27 Broker-dealer Parent firm # of advisors (Rounded to the nearest hundred) DTCC annuity services used Clearing firm affiliation(s) New England Securities MetLife Inc. 2,100 Not listed Pershing Ameritas Investment Corp. Capital Financial Group Inc./H. Beck Inc. CUNA Brokerage Services Inc. Lincoln Financial Network NYLife Securities Park Avenue Securities Securian Financial Services Inc. Ameritas Life Insurance Co. Minnesota Mutual Companies Inc. 1,700 Not listed NFS, Pershing, RBC Correspondent Services used, 1 in testing, not application Pershing CUNA Mutual Group 500 Not listed Pershing Lincoln National Corporation New York Life Insurance Company Guardian Life Insurance Co. Minnesota Mutual Companies Inc. 8,300 6, not application 6,500 5, not application 2,300 3, no application 1,100 6, no application Signator Investors Manulife Financial 1,600 7, no application SII Investments Inc. Transamerica Financial Advisors Investment Centers of America Inc. Princor Financial Services Questar Capital Corp. Jackson National Life Insurance Company 600 6, not application AEGON 4,600 6, not application Jackson National Life Insurance Company Principal Financial Services Inc. Allianz Insurance Co. of North America NFS, Pershing NFS NFS Pershing NFS Pershing Pershing 400 Not listed Pershing 2,300 1 used, 3 in testing, not application used, 1 in testing, not application Pershing Pershing Source: Company disclosures, NSCC, Investment News, The Advisor Center, DTCC "Active Distributors," Aite Group 27

28 Insurance broker-dealers have also made good progress with new account opening capabilities over the past four years (Figure 13). Carrier home offices are either making or planning to make progress with new business STP for insurance-affiliated broker-dealers but will find this difficult without adequate electronic order entry capabilities for annuities (Figure 14). Figure 13: Insurance-Affiliated Broker-Dealers Adopt Clearing-Firm Account Opening Q. Where does your firm source its new account opening/client onboarding solution used to open advisory accounts? (N=7 of the leading fully disclosed insurer-affiliated broker-dealers) Source: Aite Group, interview of 7 leading U.S. insurance-affiliated broker-dealers, June 2013 Figure 14: Carriers Are Improving STP for Their Affiliated Broker-Dealers out of 7 firms Manual Proprietary Vendor solution Clearing firm solution Q. What level of STP is available to the home office? (N=7 of the leading fully disclosed insurer-affiliated broker-dealers) out of 7 firms 5 Partial STP Partial STP with planned improvements Full STP 0 Source: Aite Group interviews with 7 leading U.S. insurer-affiliated broker-dealers 28

29 ELECTRONIC ORDER ENT RY OPTIONS FOR NON-TOP 10 DISTRIBUTORS Four vendors comprise the U.S. electronic order entry market for annuities Ebix, Aplifi, ipipeline, and Insurance Technologies. These four vendors are compared in Table G. For the past 10 years, Ebix and Aplifi have provided the two primary vendor alternatives for annuity carriers. With its October 2013 acquisition of Aplifi, ipipeline has made a large bet on its ability to grow beyond insurance agents and life insurance products into electronic order entry capabilities for broker-dealers and banks in the annuity market. Insurance Technologies entered this market in 2012 with its FireLight electronic order entry product and now provides a fourth vendor alternative for annuity carriers. E B I X Ebix is currently the predominant electronic order entry product for annuities for top 10 distributors, top 20 annuity carriers, and the current market overall. AnnuityNet uses a reflexive question approach to order entry and provides proven capabilities for annuities-related compliance and suitability. Ebix offers AnnuityNet to 240 banks and smaller broker-dealers through its correspondent platform. With the correspondent platform, large clearing firms like Pershing, NFS, and Southwest Securities integrate AnnuityNet with brokerage accounts and back-office systems to provide a one-stop solution for non-top 10 banks and broker-dealers. In early 2014, Ebix will offer AnnuityNet-lite, which will be pre-integrated with the Ebix SmartOffice CRM application. Smart Office is widely used by 200 brokerage general agents (BGAs) as well as a large number of career agents. The AnnuityNet-Smart Office integration will compete directly against ipipeline in its core BGA market. I P I P E L I N E IPipeline, with its October 2013 acquisition of Aplifi, will now become a legitimate player in the annuity electronic order entry market. This complements its dominant position in the life insurance order entry and overall forms market, including a U.S. customer base of 120 carriers and 1,200 distributors. The great majority of ipipeline's distributor customers are BGAs and other insurance agents. The company's intelligent forms approach has resonated well over the past decade with independent and career agents selling life insurance products, leading to its dominant position in that market. With the acquisition of Aplifi, ipipeline will now have a strong product offering for broker-dealers and banks in the annuity market who require the robust annuity suitability and overall compliance capabilities that Aplifi's AFFIRM product provides. By leveraging ipipeline's dedicated sales and customer support team of 12 people to support smaller insurance agents and brokerdealers, Aplifi can now more easily grow sales of its Affirm product in the non-top 10 distributor market. 29

30 A P L I F I Aplifi's AFFIRM for Annuities, like Ebix's AnnuityNet, uses a reflexive question approach for electronic order entry and includes most of the top 30 annuity carriers. Aplifi provides strong knowledge and capabilities with annuity-related suitability and compliance and offers scaled pricing for distribution organizations based on the distributor organization's utilization. The company has so far used a combination of webinar and in-person training to increase adoption of AFFIRM by small to midsize independent broker-dealers and independent agents. Access to ipipeline resources will now allow Aplifi to more easily scale its sales, training, and support capabilities. I N S U R A N C E T E C H N O L O G I ES Insurance Technologies, new to the market over the past two years with its FireLight product, has taken an improved, intelligent forms approach for annuities order entry, relying on native, HTML5 technology. Insurance Technologies brings an installed base of 16 of the top 20 annuity carriers who use its market leading ForeSight illustration product. ForeSight is the most welldesigned illustration product and Insurance Technologies also shows its software design expertise with its easy-to-configure and easy-to-use FireLight product. FireLight is particularly well suited to smaller distributors with its ease of use and no-fee-to-advisor business model. The next challenge with FireLight will be convincing Insurance Technologies' installed base of top 20 annuity carriers, beyond the five existing top 20 carrier customers, to also use the FireLight product. Top 20 carriers have already spent millions of dollars integrating with Ebix and Aplifi but will find that adding FireLight will likely help accelerate their progress with electronic order entry for small distributors and for mobile electronic order entry scenarios. Early evidence shows that the ease of use for the FireLight product should minimize ongoing training and support requirements for the product; however, carriers should complete their own beta tests and pilots with FireLight to ensure that this is the case. Table G: Electronic Order Entry Alternatives for Non-Top 10 Distributors Provider Insurance Technologies Product name FireLight Annuity product coverage Variable, fixed indexed, deferred, immediate Distributor, carrier coverage 13 active annuity carriers: 5 in top 20, 8 in top 50, 1 top 50 broker-dealer (other, smaller distributors difficult to measure # because of carrier subscription business model) Technology approach Intelligentforms filling approach using modern HTML 5 technology; suitability built in; proprietary e-signature capabilities built in Licensing approach No fees to distributor, carriers pay subscription and transaction fees Key differentiators Installed base of 16 of the top 20 annuity carriers use their highly respected ForeSight illustration app for annuities 30

31 Provider Product name Annuity product coverage Aplifi AFFIRM Variable, fixed indexed, deferred, immediate ipipeline igo e-app All fixed annuity types indexed, deferred, immediate Ebix AnnuityNet AnnuityNet Lite Variable, fixed indexed, deferred, immediate Distributor, carrier coverage 40 annuity carriers; 6 of the top 50 distributors, including 4 of top 15; access to 700 banks and 3,000 independent; broker-dealers through LPL 4 live carriers for annuities; 800 brokerage general agents and smaller distributors currently use igo for life insurance electronic order entry All of the top 20 carriers; 8 of top 10 distributors; correspondent platform provides access to 240 banks and brokerdealers through Pershing, NFS, Southwest Securities, other clearing firms Technology approach Wizard, reflexive questionnaire approach; suitability built in; integration with third party e- signature solutions Intelligent forms filling approach; suitability not built in yet; proprietary e- signature approach or integration with third party e- signature solutions Wizard, reflexive questionnaire approach; suitability built in; integration with thirdparty e- signature solutions Licensing approach Low fees to distributors; carriers pay subscription, transaction, other fees Distributor fees determined by utilization, integration, customization. Carriers pay annual license and transaction fees based on available products and distribution partners Distributors and carriers pay subscription fees; transaction, other fees for carriers Key differentiators Large installed base of annuity carriers using the AFFIRM product; infrastructure reliability no outages since 2006 Large installed base of carriers and distributors that access forms using ipipeline; dominant market share for life insurance e-app with insurance agents and life carriers as well as with BGAs who sell fixed annuities Dominant installed base of largest distributors and annuity carriers; integration opportunities with dominant, Ebix-owned, SmartOffice life and annuity CRM product in BGA market Source: Aite Group 31

32 NEW RETIREMENT INCOME SOLUTIONS NEEDED TO DRIVE LONG-TERM GROWTH Effective annuity STP capabilities play a key role in supporting the growth of carriers' annuity businesses but, ultimately, it is the extent to which annuity products can meet investors' most important retirement income needs that will drive growth. (See Figure 1 at the beginning of this report.) Mass-market and affluent investors want guarantees that help them ensure at least a floor level of retirement income in old age. Their past behavior in not annuitizing annuity products also indicates that they want to maintain control of their investment assets. Combining low-cost variable annuities to provide tax-sheltered accumulation with deferred income annuities for a floor level of income in old age meets this need at an acceptable cost to investors (Table H). Table H: Low-Cost Variable Annuity and Deferred Income Annuity for Income Floor Fees (% of assets) Combine deferred income annuity and low-cost variable annuity Actively managed equity mutual funds Actively managed bond mutual funds Guarantee fee* 0.00% Insurer administration** 0.20% Underlying funds*** 0.13% to 0.92% 0.92% 0.65% 0.13% Total ~0.33% to 1.12% 0.92% 0.65% 0.13% Index mutual funds Source: Morningstar Q for variable annuities, Investment Company Institute 2012 for the mutual funds types in the table * No guarantee cost for investor for the deferred income annuity, but the investor does not have access to the money supplied to the annuity carrier to provide the income floor that activates decades in the future. Excludes mortality protection. ** Assume US$500 per year in administration fees and an average US$250,000 account size less twice what Jefferson National charges. No commission to adviser, so no surrender charges for investor. Also no 12b-1 trailer fees. ***The underlying fund fees depend on the type of underlying mutual fund, ETF, or other investments used. KEY PRODUC T D ISRUPTIONS MAXIMIZE F LEXI BILITY, MINIMIZE RISK Disruptive product innovations by new and existing carriers have already started to address investors' most important retirement income needs. With significant venture capital and private equity focused on this opportunity area, the innovation will continue to accelerate and then cause disruptive changes to the processes by which financial advisors deliver advice and ongoing services to investors that use annuity products (or the guarantee and tax-deferral elements within annuity products). 32

33 A L O W - C O S T, F L E X I B L E, M A N A G E D A C C O U N T P R O D U C T The first key product disruption relates to the unbundling of the key tax-deferral features of variable annuity products from the underlying assets being managed. With private equity backing, Jefferson National has built a technology platform that provides an open architecture variable annuity. It allows advisors to choose from more than 400 different investment options, alternative and non-alternative, and to tailor investment portfolios to their customers' particular retirement income and overall needs. Adopting the product are 2,000 advisors, two-thirds of which are RIAs and one-third of which are fee-based, registered representatives. Direct marketing to advisors, instead of expensive wholesaling, keeps costs down, and a robust asset management platform for the advisor provides the necessary integration with custody providers, turnkey asset management platforms, and critical functions like rebalancing and performance reporting. Jefferson National will grow from US$170 million in 2010 revenue to US$270 million in 2012, US$400 million in 2012, and US$700 million in 2013 a 60% compound growth rate. As broker-dealer firms move to fee-based business models, expect approaches like Jefferson National's to go mainstream. C A R R I E R - E F F I C I E N T L O N G - T E R M R E T I R E M E N T I N C O M E G U A R A N T E E S The second key product disruption relates to providing long-term, lifetime income guarantees that investors can activate as early as 13 months from initial funding and up to 40 years in the future. Carriers can manage risk by explicitly matching the level of income with the level of funding and amount of time to invest the funds received from the investor. By providing the long-term income floor to the investor, the investor and his or her advisor can then focus on accumulation and take more risk. The fact that some of the most creditworthy carriers, such as New York Life Insurance Company and Lincoln Financial Group, provide this product makes it a sustainable, high-growth market. With the product being introduced only within the past three years, sales grew from US$210 million in Q to US$540 million in Q a 157% growth rate. Aria, with significant venture capital funding and in partnership with Transamerica, has unbundled the tax deferral and the lifetime income guarantee from any particular variable annuity product chassis and wrapped the deferred tax and guarantee around a large menu of investment fund options for RIAs or other fee-based advisors. Aria has formally unbundled the tax deferral and the income guarantee and offers these as a stand-alone product. Aite Group expects innovation like the above to accelerate so that the income-guarantee and tax-deferral advantages of annuities can expand to a wide range of asset classes and retirement plan types and to a much larger percentage of the overall US$20.9 trillion in U.S. retirement assets (Figure 15). 33

34 Figure 15: Annuity Carriers Well Positioned to Provide the Tax and Guarantee Overlay for a Wide Range of Investment Products Bonds Stocks Life annuity and mortality credit overlay Alternative investments Source: Moshe A. Milevsky, "Life Annuities: An Optimal Product for Retirement Income" Cash FROM PRODUC T INNOVATION TO PROCESS INNOVATIO N As RIAs and independent broker-dealers with sophisticated retirement income capabilities take advantage of products like the above, they will also optimize the processes that they use to advise investors in this area and provide ongoing services to the investors that use highly tailored retirement income solutions. Successful advisors will be trained to take a very scientific approach to retirement income, dynamically balancing investment approaches over time with their investors' lifetime income needs and doing so in the most tax-efficient way possible. This will be disruptive to an industry in which only 33% of 58- to 65-year-old people and 39% of 47- to 57- year-old investors even have written retirement plans (Figure 3). Advisors, carriers, and other financial services providers must artfully communicate retirement income needs as well as provide a scientific, integrated approach to implementation (Figure 16). 34

35 Figure 16: Technology and Process Components of an Effective Retirement Income Solution Advisor training Consolidated, household-level account view Source: Aite Group Performance measurement, monitoring CRM client data Automated funding and implementation Income planning software Advisor training provides the single biggest challenge and opportunity area for carriers and distributors that want to provide better context for their product sales with effective retirement income solutions. Instead of focusing just on meeting FINRA regulatory requirements, carriers and distributors should require comprehensive, rigorous training across products and focus on how to implement real retirement income strategies not prescripted product sales. These strategies should combine optimized, floor-level guaranteed income with the appropriate, lowcost accumulation strategies that allow investors to manage inflation risk. Carriers that offer guaranteed-income solutions need to staff up with certified financial planners (CFPs) or other trainers that can effectively train advisors how to implement effective retirement income strategies. Once trained, the advisors' CRM service provides the key technology integration point for retirement income solutions because pre-fill of client data with income planning, performance monitoring, electronic order entry, and other applications will increase productivity and support advisor adoption. CRM services will also allow advisors to become more proactive, alerting themselves and their investor customers when changes to the existing retirement income plan are required. 35

36 The CRM service should also help to provide a household-level view of the customer and integrate with a third-party account aggregation application like Albridge to provide a consolidated view of the investors' and household members' investments. The tax cost basis of all investment holdings must be understood to avoid costly mistakes with income planning, and income and assets of other household members must also be understood. Once customer needs and investment holdings are understood, income-planning software should illustrate the appropriate range of retirement income scenarios with different planning scenarios and product combinations. The income planning software should extend the capabilities of most financial planning software and more intuitively illustrate the retirement income scenarios so the investor and advisor can discuss them and convert them into an implementation plan. Product implementation needs to be as easy as possible for the advisor. Prebundled accumulation and guarantee products funded through a single customer account and transacted with electronic order entry provides the ideal scenario. Like that enabled through Ebix's AMP product, withdrawals and after-the-initial-sale activities should flow back into the advisor workstation or portal so that the advisor can maintain a consolidated view of all related product activities. The funding should occur through a centralized, integrated account. Integrated, ongoing performance measurement and monitoring should be in place to execute the plan, track progress against the plan, and make ongoing adjustments. Pershing's NetX360 platform provides the best available solution for bank and non-self-clearing, independent-broker dealers that want the key technology components for a retirement income solution. Envestnet provides an out-of-the-box retirement income solution that focuses mostly on the RIA market and includes some of the above components. Annuity insurers should focus immediately on banks and affiliated, independent broker-dealers to implement these kinds of solutions, providing the necessary product and other training where necessary and relying on clearing platforms like Pershing to provide the technology backbone. 36

37 RECOMMENDATIONS Aite Group recommends that annuity carriers: Make your retirement income strategy a key part of the business case for integrating with Ebix's AMP product. To implement effective retirement income solutions, advisors will need access to all after-the-sale activities with the investors' products. Complement the hard-cost, customer service business case with this more compelling business case. Use RegEd's annuity training exchange platform to update advisor-training status and streamline the communication between advisors and carriers related to the 2010 state-, product-, and carrier-specific requirements for detailed product training. When coordinating advisor training, verify that communication breakdowns are not happening between carrier and broker-dealer compliance or operations departments. Re-allocate human resources investments from annuities wholesalers to certified financial planners or other parties that can train career or third-party advisors in effective retirement income planning and implementation processes. If you have 401(k)/defined-contribution businesses, build formal cohesion between those business units and annuities business units. 401(k) and IRA rollovers are the single biggest opportunity for annuity carriers, so those that can influence both the defined contribution plan and the ultimate source of lifetime retirement income should do so. At least begin to experiment with fee-only variable annuity products. A persistent market trend is toward fee-based accounts and compensation both through large broker-dealers and with the continued growth and importance of the RIA distribution channel. Aite Group recommends that non-top 10 banks and independent broker-dealers: Remove ticket fees to advisors that help drive them away from using electronic order entry annuity entry on popular correspondent clearing platforms like Pershing and NFS. Reduced compliance risks drive the business case for doing this. Increase commissions or fees for advisors that use electronic order entry and invest significantly in advisor training for electronic order entry use, if necessary. Require that your correspondent clearing platform provider offer alternatives to Ebix for electronic order entry particularly FireLight and AFFIRM. 37

38 RELATED AITE GROUP RESEARCH Insurer-Affiliated Broker-Dealers at a Crossroads, June Account Opening Pain Points in the Front Office: Advisors in the Dark, September Retirement Income and Investor Types: Pre-Retiree and Retiree Differences, September Annuities Straight-Through Processing: The Long, Winding Road, November

39 ABOUT AITE GROUP Aite Group is an independent research and advisory firm focused on business, technology, and regulatory issues and their impact on the financial services industry. With expertise in banking, payments, securities & investments, and insurance, Aite Group's analysts deliver comprehensive, actionable advice to key market participants in financial services. Headquartered in Boston with a presence in Chicago, New York, San Francisco, London, and Milan, Aite Group works with its clients as a partner, advisor, and catalyst, challenging their basic assumptions and ensuring they remain at the forefront of industry trends. AUTHOR INFORMATION Todd Eyler [email protected] CONTACT For more information on research and consulting services, please contact: Aite Group Sales [email protected] For all press and conference inquiries, please contact: Aite Group PR +44.(0) [email protected] For all other inquiries, please contact: [email protected] 39