Immediate annuities (IAs) are a small segment of the overall fixed annuity (FA) market, pulling in an estimated $6.14 billion in 2006 sales in the United States–just 8.7% of the $70.9 estimated overall market, according to Beacon Research data.
However, IAs also provided the only bright spot in an otherwise bleak 4th quarter, when sales of all product types fell an estimated 15.9% from the 3rd quarter 2006. They were the only FA product type to post a quarter-on-quarter increase.
True, 4th quarter IA sales were up only slightly (2.5%), but this was on top of the 3rd quarter's 9.7% quarter-to-quarter growth. The line has grown steadily from only 6.1% in 2003.
Why? There appears to be an underlying level of market demand for IAs which operates somewhat independently of the interest rate environment.
Also known as single premium immediate annuities (SPIAs) or payout annuities, these products provide a series of payments for a chosen period–single- or joint-lifetime, or some combination of the two. They are commonly used for income replacement in retirement, often important in distribution of assets for that purpose.
The growth they have been experiencing has occurred even though historically low long-term interest rates are reducing payouts and even though the stock market saw strong growth throughout 2006. A plausible explanation is that SPIA sales are motivated mainly by need, not movements in interest rates or equities markets.
The potential demand is certainly growing as older baby boomers begin to retire. And awareness of the benefits of annuitization is probably increasing due to considerable ongoing positive publicity. As longevity lengthens and concern regarding Social Security's solvency widens, the SPIA value proposition is both simple and important. They can offer income for a lifetime–income that cannot be outlived–and it appears most buyers are using IAs for precisely this purpose.
Consider: Lifetime payout products accounted for almost 81% of 4th quarter 2006 SPIA sales reported by carriers participating in Beacon's annual survey.
This indicates that payout annuities are not being used primarily to finance life insurance policy premiums. Neither are they utilized mainly to delay (and therefore maximize) Social Security payments and defined benefit pension payments, nor are they used in tandem with longevity insurance (with SPIA payments ending at the age when longevity payments begin). All these alternative applications involve payouts over a limited time period (a term certain), not for a lifetime.
It will be interesting to see whether term certain payouts claim a larger share of SPIA sales as producers and consumers become more familiar with the ways these annuities can be used to achieve different objectives.
SPIAs are generally not purchased by way of IRA, 401(k) or other qualified plan rollovers. In the qualified market, the percentage of IA sales tends to be the lowest of all product types. In the last 5 quarters, for instance, qualified money has accounted for 26%-33% of participants' SPIA sales versus 38%-41% of their overall fixed annuity sales. This suggests IAs are being used primarily to supplement income from pensions and other retirement plans (as well as Social Security) rather than as a vehicle to distribute retirement plan assets.
It makes sense to purchase IAs with non-qualified funds if tax minimization is an objective, because an exclusion ratio designates a portion of each payout as a non-taxable return of capital.
