Some features that have been added to variable annuities in the past few years have long been a concern. Our worries stem from the risks these features pose to insurers that provide financial guarantees to what are basically equity investments.
Recent events seem to have proven our concerns right.
It was not all that long ago when any consumer could have found a VA with various "alphabet soup" enhancements providing guarantees to contract values. Today, these enhancements have all but disappeared as a result of the economic chaos of the past 18 months. Insurers found the risks inherent in providing contract value guarantees for equity investments were too great and that the financial instruments necessary to hedge these risks were either not available or were too expensive to obtain.
To be sure, not all of these enhancements, as designed, had the same degree of risk. The designs varied by insurer, and some insurers restricted the investments that could underlie a VA and still take advantage of the enhancement.
Obviously, speculative equity investments with cash value guarantees provide a form of "investment anti-selection" for the VA contract owner. Many VA purchasers found themselves happy they had bought before the economy went south.
The lesson to be learned from this is an old one–that anything too good to be true will not be true.
From their very beginning, VAs were intended to provide retirement security free from the ravages of inflation. However, this design feature only works when the VA is treated as a long-term investment. When held for an extended period, investments in a diversified portfolio of American stocks have tended to protect against inevitable inflation. But, this feature requires patience.
In the short-term, the stock market fluctuates, so VA values can go down, often significantly, and that may not be what the consumer expected. That's difficult to explain when discussing retirement funds. A retired person wants as much economic certainty as possible. While a VA may provide long-term economic certainty, it cannot do so in the short-term.
Therefore, it is essential for VA purchasers to understand the need to diversify not only at the portfolio level, but also to protect against market volatility with fixed products. That's why virtually all VAs also have a fixed side–to provide a degree of economic certainty in an uncertain environment.
