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Annuities providers continue their campaign for new tax breaks and angle to play a role in any privatization of Social Security. Post-September 11, they're doing it sotto voce.

By Eric Laursen
December 2001
Institutional Investor Magazine

Philmore Anderson has never worked as a teacher, but in the wake of September's terrorist attacks, the senior lobbyist for the American Council of Life Insurers has spent much of his time giving tutorials. His students: members of Congress and White House officials who need a quick course in Life Insurance 101.

On September 12, for example, Anderson took a call from House Ways and Means Committee chairman Bill Thomas, a Republican from California, who he had run into at a private social function two nights before. Thomas wanted to know how the industry would handle claims: Would life insurers make it easier for victims' families to file death benefits claims? Would they invoke policy exclusions that release them from paying benefits in the event of war or terrorist attacks?

"We're keeping our promises," Anderson assured him. "There will be no exclusions, and we're aggressively seeking at the state level to assure that claims will go out as fast as possible."

Anderson repeated that refrain again and again - to House Financial Services Committee chairman Michael Oxley, a Republican from Ohio, and to White House officials, among others - in a weeklong whirl of phone calls and meetings. The assurances were echoed by the 12 CEOs who met with the president on September 21 (among them: Hartford Financial Service Group's Ramani Ayer, American International Group's Maurice (Hank) Greenberg, Chubb Corp.'s Dean O'Hare and Robert O'Connell of Massmutual Financial Group). Insurers would waive war and terrorism restrictions. And in New York, life insurers worked with state regulators to create a simple affidavit that family members of people killed at the World Trade Center could submit instead of death certificates, which were difficult to obtain in the first few weeks after the attacks.

Yet despite the catastrophe, life insurers should emerge in relatively strong shape. They will be liable for some $4 billion in payouts to victims' survivors - a significant sum, but peanuts compared with the $40 billion to $45 billion in losses faced by insurers of property loss and business interruption. Further, the hit to life insurers' capital base should be marginal, in the neighborhood of 0.6 percent to 1.1 percent. Property/casualty insurers, by contrast, face a hit to their capital base at least ten times that magnitude, says Colin Devine, a life insurance analyst with Salomon Smith Barney.

A bill in Congress to set up a backstop fund for insurers in case of future terrorist attacks would require insurers, mostly property/casualty firms, to pay the first $1 billion in damages from any terrorist attack. Then the government would pay 90 percent of damages up to $20 billion, subject to eventual repayment.

Life insurers are pushing for relief, too, but their goals are far more modest than those of the property/casualty companies. Life insurance firms hope to persuade Congress to include in the bailout bill funding to study when it might be appropriate for life insurers to seek federal government assistance as a result of terrorist attacks. The group has also revived a series of tax relief proposals.

The real damage to the life business will come as the weakening economy and soggy stock market further depress sales of variable annuities, one of the industry's most lucrative products. In the third and fourth quarters, estimates Morgan Stanley analyst Nigel Dally, variable annuity sales will total $26.3 billion and $24.4 billion, respectively, representing declines of 26.5 percent and 20 percent over the previous year. Third-quarter profits for life insurers declined an average 13 percent, to some $2.6 billion, says Salomon's Devine.

After September 11, life insurers knew they faced a setback in their recent ambitious campaign to expand the use of annuities. Along with leading annuities providers like TIAA-CREF, life insurers have for the past several years been aggressively lobbying to push deferred annuities, which pay out upon retirement, as savings vehicles while peddling immediate annuities, which pay out at once, as income-generating vehicles for retired workers.

Traditionally less aggressive lobbyists than their counterparts in the property/casualty business, annuities providers turned up the volume in recent years. With impressive organization but not a lot of media attention, they have amassed a formidable power base. They secured a place for annuities in Florida's new public employee defined contribution plan and staved off three major revenue-raising attempts by the Clinton Treasury Department to gut the main tax advantages of fixed and variable annuities.

They scored their most dramatic success in June. With the passage of President George W. Bush's tax cut package, legislation to liberalize retirement savings regulations finally became law after five years in Congress. The bill, known for its House sponsors, Ohio Republican Rob Portman and Maryland Democrat Benjamin Cardin, gradually raises the cap on annual contributions to 401(k)s from $10,500 to $15,000 and on IRA contributions from $2,000 to $5,000; it also makes it easier for employees to take their 401(k)s with them when they change jobs. Annuities providers hope these changes will spark a new burst of savings, which should eventually increase the total pool of assets available for annuitization when employees start to retire.

"Life insurers have raised their profile," says Portman, a key congressional advocate of reform. "In so doing, they have played a very constructive role in educating members of Congress about the issue of retirement savings."

They certainly wield a lot of financial clout. Today annuities providers control $1.78 trillion in privately managed pension and retirement assets, 20 percent of the total and three times as much as they managed ten years ago, according to the ACLI. It's a highly concentrated industry: The top ten firms control just over half the cash flow in variable annuities, the industry's most popular retirement product, according to Info-One Service.

With 60 million to 70 million baby boomers expected to hang up their boots over the next 30 years, the annuities industry is angling to position itself as a guarantor of "retirement security," says Joseph Gasper, president and COO of Nationwide Financial. Adds Gasper, who became chairman of the ACLI this fall, "As an industry we're going to have to continue to educate Congress about how annuities work, their benefits to individuals."

As their current big initiative, annuities providers want to persuade lawmakers to change the tax status of earnings on annuity payouts from ordinary income to capital gains, which the majority of retiring workers would prefer. Their proposal is dubbed LAP, for lifetime annuity payout. Representatives Phil English, a Pennsylvania Republican, and Karen Thurman, a Florida Democrat, introduced a LAP bill in the House last month. The suggested new tax status - which money managers will vehemently oppose - would give annuities a leg up on mutual funds, whose 401(k) payouts are taxed as ordinary income. Now that LAP has a sponsor, lobbyists at the ACLI believe they can persuade lawmakers to turn their attention to that bill early next year.

With lawmakers focused on the fallout from September 11, annuities providers will be lobbying sotto voce for some time to come. On the insurance front the problems of property/casualty insurers took center stage as Congress raced last month to set up a government backstop for terrorism coverage. More broadly, the economic stimulus package still being hammered out aims to spark new consumer spending - not to promote retirement savings.

Life insurers have had great success in amassing retirement assets, but they still lag behind their rivals in selling the two most popular types of retirement savings accounts - 401(k)s and IRAs. Annuities now claim just $242 billion of the $1.8 trillion in 401(k) assets and $245 billion of the $2.5 trillion in IRAs.

For years, investors have overwhelmingly preferred deferred variable annuities, which are invested like mutual funds and are not taxed until payouts begin at retirement, to immediate annuities, which provide a stream of income upon purchase. But immediate annuities represent an attractive product for an investor who is retiring and is looking for either a steady, guaranteed income stream or a guaranteed minimum income with some upside potential.

Insurers have been eager to push these immediate annuities, in part because sales of deferred variable annuities have declined as stock values have fallen. New contracts totaled $45.3 billion last year, down from $64 billion in 1999. In 1999, according to the ACLI, fewer than 2.7 million people held immediate annuity contracts, versus 68 million-plus holding deferred annuities. Less than 2 percent of annuities providers' assets under management are currently in immediate-payout products, says Bob Stein, head of Ernst & Young's global financial services practice.

Behind the scenes, insurance lobbyists are maneuvering to help define the debate over Social Security reform to assure that their products win a prominent role if a system of private accounts is adopted. The presidential commission on the issue, chaired by former New York senator Daniel Moynihan and AOL Time Warner co-chief operating officer Richard Parsons, has not yet presented its report, but it will likely consist of a series of possible frameworks for a privatization plan.

Until 1990 life insurers were pretty quiet in Washington. Then the government levied a new tax on the deferred acquisition costs - commissions and other business expenses - that insurers incur with the sale of each new insurance policy or annuity contract. The new tax woke the insurers up.

To stave off further setbacks, the industry began some serious lobbying. Life insurers found a strong champion in Carroll Campbell Jr., whom the ACLI hired as its president and CEO in 1995, at a salary of $1 million a year. The former Republican governor of South Carolina had already built a formidable set of connections during four terms in the House, serving on the Ways and Means, Appropriations and Banking Committees. (Campbell announced his retirement in October after learning that he had Alzheimer's disease.)

In the mid-1990s life insurers were reinventing themselves, shifting from suppliers of life policies to providers of investment and retirement services. "Fifteen years ago 60 percent of the money that was going into company products was life insurance. Now, two thirds is going into retirement and pension products," says Campbell.

Annuities quickly emerged as the industry's signature product, especially deferred variable annuities, which enable investors to build up tax-deferred assets during their working years. Variable annuity premiums exploded from $4.7 billion in 1989 to $135.5 billion in 1999. Still, that growth paled next to mutual funds, whose new cash flow increased from $44.4 billion to $363.4 billion, according to the Investment Company Institute.

The Treasury Department made three separate attempts to coax tax revenue out of annuity providers, in 1998, 1999 and 2000. Each time, insurance lobbyists hit the Hill, and Treasury abandoned the proposals within weeks. "They were all dead on arrival," says new ACLI chairman Gasper.

Those victories were a warm-up for the industry's most significant triumph, its critical efforts on behalf of retirement legislation earlier this year.

The industry clout was on full display one morning in March, in EF-100, a large chamber in the Capitol Building, directly below the Rotunda. Here 20 top life insurance company executives sat on straight-back chairs and championed the cause of the Comprehensive Retirement Security and Pension Reform Act, soon to be incorporated into the Bush tax cut package, as a succession of senators and representatives peppered them with questions and comments.

The lawmakers included four members of the powerful Senate Finance Committee: Republicans Don Nickles of Oklahoma and Phil Gramm of Texas, and Democrats Kent Conrad of North Dakota and Max Baucus of Montana. "Our CEO summit in Washington was held at a point that was crucial to the process, when hearings were about to be held in the Senate," says John Turner, vice chairman of ING Group.

Baucus and Finance Committee chairman Charles Grassley, a Republican from Iowa, were unsure whether to try to slip the legislation into the president's tax cut bill, then being debated, or to set it aside for later in the year. But annuities lobbyists told Baucus about a meeting the CEOs had attended earlier that day at the White House, in which White House chief of staff Andrew Card Jr., economic adviser Lawrence Lindsay and political strategist Karl Rove had indicated that the administration would not object to an effort to include Portman-Cardin in a tax bill.

"Concerning Portman-Cardin, the White House advisers said they weren't going to tell anyone how sausage is made on Capitol Hill," says one lobbyist familiar with the conversation. "Officially, it was a yellow light, but we took it as a green light." Baucus left to spread the word.

When annuities providers left the Hill, they intensified their media blitz on behalf of Portman-Cardin. All told, in two years the ACLI spent $1.3 million on its advertising campaign for the bill. Says one Democratic committee staffer: "There was nothing to compare with the annuities industry. Their lobbying for Portman-Cardin was phenomenal."

While elements of Portman-Cardin were being wrestled into law, annuities providers were flexing their muscles in a southern state capital.

For more than a year, they had been working to persuade Florida's State Board of Administration to transform its defined benefit plan, the Florida Retirement System, into a system that includes a defined contribution component (Institutional Investor, April 2001). A debate over the terms of the law pit retail money managers, including annuities providers, against institutional asset managers. Says Malcolm Campbell, vice president and chief counsel for government relations at TIAA-CREF, "We were saying that a bundled design, with annuities, ought to be part of the mix."

Thanks in large part to lobbying by annuities providers, as well as lawsuits filed by TIAA-CREF and Variable Annuity Life Insurance Co., or Valic, the state agreed to set aside two or more openings for bundled providers, so-called because they sometimes bundle administrative services and education with investment management.

The SBA selected four providers late last month - ING-Aetna Financial Services, Fidelity Investments Tax-Exempt Services Company, Prudential Retirement Services and Nationwide Retirement Solutions - but were still negotiating with a fifth, Valic. They also picked an annuity provider, Hartford Life Insurance Co., for retiring workers who elect to annuitize their defined contribution assets rather than take a lump-sum payout.

The industry's next fight takes its lobbyists back to Washington, where they hope to plant the seeds for a new tax bill.

"Portman-Cardin focused on helping people accumulate retirement assets," says Angela Arnett, senior counsel at the ACLI. "LAP is looking at the distribution of those assets in retirement."

LAP is designed to encourage individual policyholders to take payouts on annuities by reducing the tax liability on those payouts, reclassifying the earnings on those payouts as capital gains rather than ordinary income.

LAP's tax basis shift would thus give an edge to annuity providers as they compete with mutual fund companies for assets that retiring workers remove from their 401(k) and IRA accounts. Withdrawals from these mutual funds are now taxed as ordinary income.

Since the proposal calls for the change to apply only to nonqualified accounts - annuities that are not included in defined contribution plans or IRAs - the annual revenue hit to the federal government would be only about $1 billion. But it would give annuities providers marketing ammunition.

"If there's an incentive that if you annuitize your account - the federal government will give you a tax break - the immediate annuity now becomes an attractive tool for financial planning," the ACLI's Gasper says.

"I'm sure it will be fought vehemently by banks and mutual fund companies to the extent that they think it will give a distinct advantage to the insurance companies," says Ernst & Young's Stein. The Investment Company Institute, the leading trade association for mutual fund providers, declines to comment on LAP.

Portman has looked closely at LAP and supports its basic intentions (the industry would be delighted to sign him as a legislative sponsor). Another House member, Republican Nancy Johnson of Connecticut, reportedly has given it some serious attention.

Of course, the LAP bill that Representatives English and Thurman introduced last month will not move to the top of the congressional agenda anytime soon. As annuities providers make their case, they clearly confront a Congress - and a public - preoccupied with the war on terrorism as well as a looming recession.

"There's no doubt that for quite a while our country will be focused primarily on issues involving the war against terrorism, and rightly so," says Gasper. "But what we have heard is that we must remain open for business. That applies to work on Capitol Hill as well."
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