Every time interest rates go up there is a flurry of demand for a product that has been around at least since the Roman Empire — annuities. The insurance industry has already seen rapid growth in annuity sales since 2021 and if rates remain at or move above current levels, demand seems poised to explode.
There’s been some hand wringing of late about whether annuities could be bad for investors, for insurance companies or even for the financial system. The concerns spring from changes to the structure of the industry and the products themselves. Private equity firms have gotten into the business, buying public insurance players or starting new private ones, and now represent 10% of the sector. Both new and old insurance companies are using more leverage and expanding their holdings of exotic assets such as collateralized loan obligations and reinsurance contracts to fund annuities. In addition, insurers are offering greater liquidity to investors, raising the risk of bank-run-type disasters for the companies.
All these changes could lead to a race to the bottom where the most aggressive companies offer the highest annuity rates, win a bigger share of new business, chase the riskiest strategies to fund them and, eventually, collapse first. A big enough collapse could cause systemic problems in the financial system. It’s not clear that state insurance regulators can keep up with the changes.
I’m not going to discuss annuities used by wealthy investors with professional advice for tax savings, estate planning or creditor protection. Those are specialty needs that do not apply to most investors and do not represent a significant share of the annuity market.
The basic annuity of most interest to individual investors is one that is purchased for a lump sum, and makes monthly income payments that rise with inflation, for the lifetime of the beneficiary, with zero value upon death. The amount of income insurance companies offer depends on three main factors: the long-term real interest rate, the life expectancy of the beneficiary, and the amount of investment risk the company is willing to take.