It’s a uniquely difficult time for retirement planning. Because of the pandemic, the economy is on edge. Equity markets are volatile, and interest rates remain at record lows. So it’s not surprising that annuities—a key tool for retirement planning—are in a tizzy, too.
According to the Secure Retirement Institute (SRI), total annuity sales plunged in the second quarter by 24% from the corresponding period a year ago, to just under $49 billion. Both of the two main types of annuities saw steep declines: Variable annuity (VA) sales dropped 20% after four consecutive quarters of growth, and fixed-annuity sales slumped 26%.
Predictability Is Preferable
“Traditionally, during periods of low interest rates, individuals are more likely to seek variable annuities,” says Teodor (Teddy) Panaitisor, an SRI senior research analyst based in Windsor, Conn. “However, in recent months we have seen fixed products … gain more traction than other annuity products. This is due to the high volatility and uncertainty we’ve seen in the equity market. As a result, individuals are seeking these fixed products for safety and principal protection, regardless of the low interest rate environment.”
VAs, of course, invest in mutual-fund-like accounts that are tied to equity markets. Fixed annuities work more like bonds, with a fixed rate of return typically based on current interest rates. The conventional wisdom says VAs become more popular when interest rates are low, and fixed annuities gain popularity when equity markets are volatile. But with both these trends happening at the same time, it’s hard to tell what to expect.
In some ways it’s almost as if investors have become used to low interest rates, but the second quarter’s market volatility was more shocking—causing a flight to greater security. In the second quarter, one of the surprising gainers was fixed-rated deferred annuities, which work much like certificates of deposit, except that the interest is earned tax-free until it’s withdrawn. For the quarter, sales of these annuities jumped 33% from the prior quarter.
“Low interest rates dampened fixed-rate deferred annuity sales in the first quarter, but as we saw during the Great Recession, these product sales soared in the second quarter as consumers looked to protect their investment from market volatility and losses,” said Todd Giesing, SRI’s senior annuity research director, in a press release.
“The most basic value that annuities provide is protecting retirement portfolios, which is especially important during times of market volatility or downturns like we’re seeing right now,” says Colin Devine, New York City-based senior education fellow at the Alliance for Lifetime Income, the Washington, D.C.-based nonprofit organization dedicated to educating people about the importance of protected lifetime income in retirement. “Given that we’ve seen low interest rates for a long time now, annuity companies have been some of the most innovative in the financial services industry, creating other types of annuities, such as registered index-linked annuities.”
A Bright Spot
And those are one of the few bright spots in the SRI report. Registered index-linked annuities are types of VAs sometimes called structured or buffered annuities because they offer downside protection (a “floor”) in exchange for partial upside participation (a “ceiling”).
These vehicles continue to sell well. In the second quarter of 2020, registered index-linked annuities sales were up 8% year over year in SRI’s measure. That was their 22nd consecutive quarter of sales growth. For the first half of the year, their sales jumped 22% from the corresponding period a year earlier.
“Being able to provide some downside protection to a portion of equity portfolios through a buffered annuity is a very prudent move for advisors to help de-risk retirement portfolios that are being challenged by this rate environment,” says David Lau, founder and CEO of DPL Financial Partners, an insurance network for registered investment advisors based in Louisville, Ky. “Clients love the products because they offer attractive upside potential while providing a level of downside protection, bringing some comfort during what has been a very rocky ride.”
For carriers, advisors and clients, registered index-linked annuities offer less risk than other VAs. For providers, they are also less capital-intensive.
“Insurance companies like diversification as much as advisors and investors do,” says Graham Day, managing director of individual retirement at Equitable in Raleigh, N.C. “Some annuity products require more capital to provide the long-term obligations of the contract, such as lifetime income features. Other products, like [registered index-linked annuities], are ‘capital light.’”
Annuity Providers Face Profit Pressure
It’s been a tough environment for annuity providers. To combat interest-rate pressure on their corporate profits, many providers are considering raising prices or canceling low-cost options.
VA income guarantees, for instance, are “quickly becoming less appealing to insurance companies,” says Don Hughett, partner and wealth advisor at Octavia Wealth Advisors in Cincinnati. Typically, he says, they are priced with the assumption of a considerably higher interest rate environment. “In response to the current environment, there has been movement in the industry designed to lessen guarantees and, in many cases, to incorporate flexibility in the guarantees ... to protect the interests of the insurers.”
Given these market pressures, annuity providers have to be careful. “When managing products, especially in a challenging environment like the one we’re facing now, it’s important for annuity providers to balance the consumer value proposition with their own long-term viability, in order to be strong and stable to meet client obligations,” says Eric Henderson, president of Nationwide Annuity in Columbus, Ohio.
Henderson noted that four of the top 10 VA providers during the 2008 financial crisis are no longer in the annuity business because they couldn’t weather the storm. “All insurers will struggle to earn a decent return and manage the credit risk in their portfolios,” he says.
Always Innovating
One way annuity providers cope with uncertain conditions and changing client appetites is by creating new products or new variations of old products. Several companies now offer products with rising income features, for instance, some of which are specifically linked to inflation and are dubbed inflation-protected annuities. “In a time of unprecedented low interest rates, it’s likely that products that offer downside protection with the ability for crediting rates to rise as interest rates increase will be attractive to investors,” says Panaitisor at SRI.
Since inflation has been less than 3% annually since the financial crisis of 2008, the market for inflation-protected annuities hasn’t been strong. Panaitisor is aware of only a limited number of such products, but allowed that it “may be an area of opportunity for manufacturers to innovate.” The benefit of a rising income annuity comes at a cost, of course, but it may be worth it for those who are worried about losing purchasing power over time and want to hedge against the effects of inflation to safeguard their retirement. Most pensions aren’t indexed to keep up with inflation, and even Social Security cost-of-living increases have historically tended to lag the general inflation rate.
Clients Want Options
Separately, DPL conducted a survey that found many advisors are reacting to the low interest rates by recommending riskier assets for their clients’ retirement portfolios as they search for yield.
“Due to our prolonged interest rate environment, advisors feel the need to dial up investment risk to meet income needs, thereby exposing clients to sequence of returns risk, which can be devastating for those nearing retirement or recently retired,” Lau said in a released press comment about the survey.
Still, many advisors and clients are satisfied with the current varieties of annuities.
“People want options, and annuities in general provide that,” says Paula Nelson, president of retirement at Global Atlantic Financial Group, based in New York City. “Variable annuities appeal most to those looking more for market growth potential over interest crediting. For interest-based saving alternatives, we see many customers looking to fixed-index annuities.”
Such annuities have a fixed rate of return, but they earn interest based on (though not actually directly invested in) the performance of an equity index. They may have greater growth potential than other fixed annuities, but lately their popularity appears to be waning. In the second quarter, fixed-index annuity sales fell 41%, the lowest quarterly total for the product since the first quarter of 2015.
Despite today’s challenges, many people find that annuities are an essential part of a smart retirement plan—perhaps now more than ever. “With the unprecedented uncertainty in the markets, economy, politics and society at large, this is actually the absolute right time to be having conversations around protected lifetime income, and annuities are still the only products out there that can provide that,” says Devine at the Alliance for Lifetime Income.
Overall, though, it seems that many clients are just holding their breath. “Many individuals are in ‘pause’ mode and are waiting until the economy settles down,” says Curtis Johnston, vice president and wealth advisor at Girard in King of Prussia, Pa., adding, “or until the election is over.”