The Essential Guide to Annuities

February 29, 2012 at 07:00 PM

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FINDING CERTAINTY IN AN UNCERTAIN WORLD

By David Port

Talk all you like about how such factors as the interest rate environment, equity market volatility and baby boomer product tastes are impacting the annuity marketplace. When it comes down to it, the factor that today has the biggest hand in shaping both the supply and demand sides of this $150-billion annual market is purely psychological. It's called uncertainty.

On the demand side, a deep-seated uncertainty among investors about the adequacy and safety of their retirement nest egg is driving them to annuities to gain access to a wildly popular breed of optional feature known as the living benefit, through which they can obtain an insurance company's guarantee of principal protection or income for life.

Uncertainty also has a grip on annuity suppliers. The escalating risk-management pressure that living benefit guarantees place on the balance sheet is prompting insurance companies to rethink their annuity product lines as well as their overall approach to the annuity market.

And in the middle of it all stand advisors like you, trying to stay plugged in to the client mindset while keeping pace with supply-side developments so you're in position to match clients with the right type of annuity and annuity features. Read on to arm yourself with the essential annuity insight you'll need to maintain a competitive edge amid all the uncertainty.

The supplier shuffle

An aversion to assuming additional living benefit-related risk is motivating big-name insurers like John Hancock and ING to scale back their variable annuity (VA) activity. "We have seen a lot of carriers pull out of the marketplace," says Kevin Loffredi, vice president at Morningstar, Inc., in Chicago.

Their withdrawal leaves a void that other insurers appear poised to fill, observes Scott DeMonte, principal at VA Edge, an annuity-oriented consulting firm in Syracuse, N.Y. "I think you're going to see new players like Midland National and mutual companies like Nationwide and Ohio National getting more involved in the [variable annuity] market. It's a good opportunity for them, because they weren't in the middle of the living benefits arms race, so they don't have those liabilities on the books."

It's also worth noting, DeMonte says, that without such liabilities, these newcomers may be in a position to offer richer living benefits than those offered by traditional VA providers.

For some carriers, it's a matter of reallocating resources. "Some traditional variable annuity carriers are really looking hard at the indexed annuity space," says Loffredi, naming Pacific Life and Genworth as examples of insurers that lately have shifted focus to index annuities.

Symetra and Hartford Life are two others to recently play up their indexed annuity offerings. And according to some observers, other big VA players—perhaps even MetLife—may soon follow suit.

De-risking persists

Discontinuing certain products and living benefits is one way for insurers to manage VA market risk. But the more popular route among carriers today is to de-risk the living benefits they continue to offer. "Their biggest issue right now is the sustainability of living benefits," says DeMonte.

Though most of today's living benefits are decidedly less rich than in years past, they cost almost double what they did just several years ago, he observes.

"Some traditional variable annuity carriers are really looking hard at the indexed annuity space." ~Kevin Loffredi, Morningstar

That's apparently not deterring investors, notes Loffredi, pointing out that some form of living benefit is elected with roughly 90 percent of new VA contracts.

The continued popularity of living benefits leaves insurers with the difficult task of striking a balance between risk management and investor appeal. "The living benefits are very near and dear to these insurance carriers," Loffredi notes, "so they're really having to get creative."

New hedging twists

That creativity has already begun to surface via a range of new product and feature designs and strategies geared toward managing risk—that of the insurer as well as the investor.

Much of that innovation is occurring at the sub-account level. Take, for example, the new guaranteed lifetime withdrawal benefit (GLWB) that Ohio National offers with its ONcore variable annuities. Not only does it offer an 8 percent annual accumulation rate and a highly competitive annual payout of 5.25 percent starting at age 65, it also features an advanced volatility-management strategy developed by risk-management specialist Milliman that incorporates TOPS exchange traded fund (ETF) portfolios from ValMark Advisers and futures-based equity positions into the annuity's sub-accounts. The TOPS-Milliman hedging strategy is designed to allow investors to capture 75 percent of upside market movements while exposing them to just 25 percent participation in downside movements.

More annuity providers are constructing hedged VA sub-account portfolios around instruments such as ETFs, and then requiring investors to allocate a portion of contract funds to those hedged portfolios. Essentially, it's a move by insurers to transfer a greater share of the risk-management responsibility associated with living benefit guarantees downstream to investors. For investors, the upside of shouldering that additional responsibility is the potential for richer benefits and lower fees on features such as a GLWB.

AXA Equitable uses a similar philosophy with its Retirement Cornerstone VA, which features a non-guaranteed, equity-invested sub-account alongside a sub-account comprised of guaranteed investments that are designed to underpin the product's optional income and death benefit guarantees. The contract holder decides when to activate the guarantee; when they do, funds are automatically shifted into the guaranteed sub-accounts.

"Easily 80 percent of the indexed annuities that we handle have an income rider on them." ~Bill Kauffman, Senior Market Sales

LBs in the FIA space

Not surprisingly during these uncertain times, the living benefits (LBs) arms race is spilling over into the fixed index annuity market, where withdrawal and income guarantees are fast becoming a fixture.

Recent estimates by LIMRA show that optional living benefit riders are available with close to 90 percent of FIA products, and that when those options are available, they're elected more than 60 percent of the time.

"Those income riders are very popular with indexed annuities," says Bill Kauffman, CLU, ChFC, vice president for financial products at Senior Market Sales, an independent marketer based in Omaha, Neb. "Easily 80 percent of the indexed annuities that we handle have an income rider on them"

FIAs attract the broker-dealer crowd

Independent advisors who are active in the fixed index annuity space better brace for more competition. The ability to package downside protection with upside potential, plus an income guarantee is drawing more sellers into the FIA space, says Kauffman. "Two years ago, registered reps for the most part were adamantly against indexed annuities. Now they're saying, 'OK, I'll look at them, because safety with upside is something my clients are telling me they want.' They're looking for a product that lets them come out from behind the desk and provide a solution to all the volatility and risk clients face today."

What's more, says Kauffman, registered reps don't need to overhaul their business model in order to sell FIAs, but rather can integrate them with other established aspects of their practice.

Loffredi sees acceptance of FIAs rising sharply among large broker-dealers, and wirehouses in particular. "Wirehouses tend to be conservative with the products they put on their shelves," he explains, "and if they're offering fixed indexed annuities, then you can expect everybody else will start doing it, too."

What clients want: A home for qualified money

Capturing the hundreds of millions of dollars in qualified assets destined to come into play as more members of the baby boomer generation become seniors and hit the magic distribution age of 70.5 is a captivating issue these days for advisors and annuity providers alike.

Indeed, qualified sales of variable annuities continue to outpace non-qualified sales by more than two-to-one. According to LIMRA International, about 70 percent of people under age 70 who purchase a VA are using qualified funds to do so.

"People who are getting close to that 70-and-a-half point are wondering about their RMDs and they want their advisors to provide solutions," explains Kauffman.

More annuity-based solutions are at hand. For example, Western & Southern's Variable Annuity for Roll Over Only Money (VAROOM) is aimed squarely at retirees seeking a home for qualified rollover money. It's structured as a VA inside an IRA, and in keeping with the de-risking trend in the VA market, it puts a heavy emphasis on ETFs among its sub-account investment options.

What clients want II: Safe havens

Uncertainty rears its head again, with equity market volatility putting a premium on principal protection. "People today are saying they're more concerned with not losing money than they are with capturing as much upside as they can," says Kauffman.

That explains the growing appeal of fixed index annuities and the built-in principal protection they provide. It also explains why single-premium immediate annuities (SPIA) are gaining appeal among senior investors, according to Kauffman.

Lately, he says, a dual annuity strategy that incorporates a SPIA to provide income and an FIA to access upside market potential is resonating with safety-minded clients. Such a combination may work especially well as a home for non-qualified assets that otherwise would be stashed in under-performing vehicles such as a CD, he adds.

What clients want III: Retirement income planning & solutions

The elephant in the room for today's 60- and 70-somethings and their advisors is retirement income. People are genuinely worried their nest egg won't prove large enough to last through retirement. And they're relying on their advisors to provide multifaceted solutions.

"Income planning is huge," says Kauffman. "Advisors have to have the ability to help people move from the accumulation to the distribution phase. Consumers expect their advisors to know something about annuities and their income guarantees, but also about Social Security, even about Medicare. Most advisors don't know much about this stuff. They don't want to mess with it. But those who do will set themselves apart. They'll be able to provide added value, and they'll do well because of that."

Parting Wisdom: Pounce on guarantees, lest they disappear

Given the uncertainty surrounding annuity-based lifetime income guarantees and the overall state of flux in the living benefits market, the time to lock in a living benefit for clients is now, says DeMonte of VA Edge. "I would advise compelling your clients to take a look at these guarantees and to do it now because in a year or two, these products might be vastly different, and not nearly as attractive as they are now—or they might not be there at all."

"I would advise compelling your clients to take a look at these guarantees and to do it now because in a year or two, these products might be vastly different, and not nearly as attractive as they are now—or they might not be there at all." ~Scott DeMonte, VA Edge

CRYSTAL BALL: 5 predictions for the year ahead

By Eric Thomes

Economic uncertainty will likely continue in 2012. But that only underscores the importance of guaranteed income in retirement.

With 2011 in the rear-view mirror, what can the annuity industry expect in 2012? It's pretty safe to assume that the economic roller coaster we experienced last year will continue, and that will no doubt pose challenges for financial professionals who sell annuities. However, the high level of economic uncertainty that flows into 2012 also provides ample opportunity to communicate the true value of annuities and their role in a well-rounded retirement portfolio. With that in mind, here are five predictions for what our industry can expect in the coming year.

1. Continued low interest rate environment. It's likely that the historically low interest rates of 2011 didn't inspire many people to invest in "safe" products that wereas of the end of Decemberyielding just over 1 percent or less. It's possible that some of that money earmarked for guaranteed financial products could have gone into other vehicles that could potentially provide higher returns. But that didn't necessarily happen, as the annuity industry experienced what will likely be a record year. So why did people stick with annuities?

It seems that people are finally starting to understand that saving for retirement isn't just about making moneyit's also about not losing the money you already have saved. If 2011 taught us anything, it's that we can't predict how the economy will perform and how factors like a soft economy will affect interest rates. Our industry has done a better job of communicating this fact of late, and will need to continue this work in 2012 as it appears interest rates won't get any better, at least in the short term. Despite this low interest rate environment, we believe annuity products remain an attractive option for consumers looking to protect a portion of their retirement savings.

2. Continued market volatility. This goes hand-in-hand with the low-interest rate environment and was something that simply couldn't be ignored in 2011. In today's media-driven society, market conditions are largely dictated by what people read in the news. Last year, there certainly weren't a lot of positive headlines. Between the debt crises in the United States and Europe, minimal job growth and fears of a double-dip recession, domestic and global economic news left the average investor confused at best. The danger with that scenario is that people often don't know what to believe. Without the guidance of a trusted financial professional, many may be content to let their money sit on the sidelines.

It's likely that the type of market volatility we experienced last year will continue in 2012. Again, this can actually be more of a positive than a negative for the annuity industry. Our clients will most certainly see troubling news headlines throughout 2012, but with a proper understanding about the benefits of annuities, they don't need to get caught up in the media hype. More education about our products in 2012 will support clients so they aren't chasing returns when the market is up or panicking when things are down.

3. November elections will spark more retirement conversations. Given the aforementioned economic news of 2011, people will make their voices heard in record numbers this year about a variety of issues, retirement included. What does this mean for the annuity industry? Only time will tell, but it's safe to assume that the retirement landscape will undergo some changes as a result, which may add to the uncertainty that many Americans may already be feeling.

As previously noted, this era of uncertainty can be an effective environment for financial professionals to champion the benefits of guarantees with retirement income. Whatever happens with the November presidential elections, retirement issues including the future of Social Security, defined benefit plans and taxes to name a few, will be a big part of the conversation. Financial professionals need to be prepared to understand the changing political and economic landscape and communicate how annuities can play an important role no matter the election's outcome.

4. New players in FIAs. Competition will increase among fixed index annuity (FIA) providers as there were several new entrants into the market near the end of 2011. These companies are realizing the downside protection and interest potential that FIAs provide and how valuable that can be in a tumultuous market. This is good news for financial professionals who offer annuities because more choice for the customer is always a positive. Competition also fosters innovation, so agents should anticipate new options to emerge in 2012 that reflect their clients' retirement concerns.

Perhaps the more compelling part of the expanded competition will be the distribution models that these new entrants choose to incorporate. Many of the new FIA providers come from a business model this is not linked to the Field Marketing Organization (FMO) distribution model of existing FIA providers. Thus, financial professionals may need to engage with new product providers in a completely new way and FMOs will need to align even closer with those companies who use their distribution platform. Flexibility will be key as these changes unfold.

5. Strong desire for safety and security. The final prediction for 2012 underscores the others, and is really at the center of where our industry should focus this year. As increasing numbers of baby boomers approach retirement, the need for guaranteed income becomes stronger than ever. Despite overtures from the federal government surrounding the wisdom of incorporating guaranteed income into defined contribution plans, real action on that front is likely a ways off. That means the bulk of the responsibility for retirement income rests with the individualand the individual, namely your client needs better guidance on how to achieve some level of safety and security in retirement.

The problem is, all of the factors mentioned abovefrom interest rates and to market volatility to political changehave given people pause. As a result, many Americans simply don't know what to do about their retirement savings. According to a recent survey from Allianz Life Insurance Company of North America, 80 percent of Americans said they were either less likely or unsure about seeking advice from a financial professional in 2012. This is a troubling statistic given the overall volatility in 2011 and speaks to the confusion about retirement planning that many Americans are currently experiencing.

That's why the basic benefit of an annuity is so powerful. The message is simple and hasn't changed. The ability for an annuity to provide an income stream that people can't outlive is paramount, and it is guaranteed by the financial strength and claims-paying ability of the insurer. This is especially true at a time when there are questions about what retirement will look like in 10 or 20 years. As such, it's important to understand that we as financial professionals need to continue to beat that drum and proactively communicate the benefits of our products no matter what happens with the economic roller coaster in 2012.

Eric Thomes is senior vice president of sales, Allianz Life Insurance Company of North America in Minneapolis

FIA holders hold on

By Maria Wood

Surrender rates of FIAs have declined. What does this mean for providers of that product?

A recent study revealed that holders of fixed indexed annuity (FIA) contracts want to keep those policies in force rather than surrender them.

In a first-ever report on the subject, Ruark Consulting, LLC of Simsbury, Conn., reviewed data on FIA full surrenders supplied by nine insurance companies between January 2006 and December 2010. Those participating companies represented more than 80 percent of 2010 FIA sales and contributed 7.7 million policy years of experience data.

Among the factors analyzed were: policy duration; age, existence of living benefit; in-the-money living benefit; policy size; historical credited rate; calendar quarter; qualified versus non-qualified status; type and level of bonus; market value adjustment; and distribution channel.

What the researchers found was that full surrender rates at the end of the time period studied were 60 percent of those at the beginning, according to Richard Tucker, vice president of Ruark, indicating that surrender rates dropped by 40 percent.

Since the report's purpose was simply to quantify the data rather than discern what was behind consumer behavior, Tucker says he cannot be certain why policyholders decided to keep their FIAs in force rather than surrender for cash or convert into another product.

However, he ventures that one reason for the decline in surrenders is that alternative investment options looked less appealing to FIA owners.

"Interest rates have come down, rates on bank CDs have come down, and the equity markets have experienced high volatility," Tucker says. "So if you look at the options available to consumers, those options became less attractive over the time period of the study."

Another reason could be that suitability requirements for the sale of annuities have become stricter during the period the study covered. Consequently, moving into another financial product is more difficult, Tucker says.

Annuity expert Jack Marrion, president of Advantage Compendium, a St. Louis-based research and consulting firm and a frequent contributor to LifeHealthPro.com, does study consumer behavior in regards to annuities and supports Tucker's contention that less competitive investment alternatives and tighter suitability standards are probably the cause of the drop in FIA surrenders. He adds another reason: guaranteed lifetime withdrawal benefits, or GLWBs.

"GLWBs made annuities stickier because the growth in the 'income benefit account' has far exceeded actual cash value account growth." Marrion writes in email comments. "For example, an 8 percent roll-up rate creates $125,971 in three years but actual accumulated value might only be $106,000. It would difficult to bonus-up with a new annuity to offset this difference. In addition, since the new NAIC suitability rules came out carriers have been much tighter on what they consider an acceptable 1035 exchange and are turning down more transfer business."

Three years ago, Marrion says he believed 1035 exchange deals would fall off and therefore producers and IMOs would need to change their business model.

"What I didn't see was that GLWB payout factors and roll-up rates would be lower, and that that old 8 percent roll-up rate might also have had a 6 percent payout factor at age 65, and the new one has a 7 percent rate and a 5 percent factor," he writes. "I also didn't see CD rates dropping nearly as much as they have. There are existing annuities out there with minimum guarantees that are double or triple current CD rates."

Although the report didn't ascertain the reasons behind policyholders' actions, Tucker says insurance companies can nevertheless use the statistics in making future decisions on product pricing, reserve levels and risk management strategies.

Marrion asserts for most carriers, a drop in FIA surrenders will not have a meaningful impact on their business. "The effect on carriers if the contracts continue to stay in forceand bond yields remain low forevercould be losses on this business block due to the higher guarantees," Marrion writes. "However, for most of the carriers this is not going to be a problem, even if GLWB utilization is high, because it is only a part of their overall business and they have lowered the guarantees on current products to be sustainable in a low-rate environment."

Marrion further points out that although bond rates have been dropping, the "odds are against a 1946-1964 scenario continuing because carriers have more financial alternatives to support yields."

Ruark has done previous studies on surrender rates for variable annuities and found a similar trend during the same time period, Tucker says.

Tucker declined to release specific details from the study, saying the information is to be shared only with participating insurance companies. However, other findings from the FIA study include:

Policies with guaranteed living benefits registered lower surrender rates than those without.
Contracts with low credited rates experienced higher rates of surrender.
When Treasury interest rates dropped in 2008 and 2009, there was temporary spike in surrender rates for contracts with positive market value adjustments.
Surrender rates varied by attained age, policy size, qualified tax status, distribution channel and bonus feature.

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