Variable annuities are not going to disappear anytime soon, even though some insurance companies are pulling back on their offerings or getting out of the business altogether.
These equity-based products can still be a good investment for clients who can’t stomach the volatile stock market or who want higher steady income than what is being produced from the current low interest rates on most bonds, CDs and other fixed-income investments, say experts. Variable annuities have been around for years, an investment that promises a guaranteed stream of retirement income with possibly some principal left over for heirs, depending on the VA’s contract riders.
But it is the variable annuity riders that have gotten some insurance companies into big trouble, according to analysts. Before the 2008 financial crisis, companies competed with each other to offer the most attractive VA deals, offering 6% to 7% valuation increases annually starting when the policyholder was as young as 59 and a half years old. In most contracts, the underlying amount on which benefits are paid goes up annually until the VA owner takes his or her first payment. After that, the base amount is locked in.
“Now you have to wait ’til 65 or even 70 years of age to get the same amount you used to get [at 59 and a half],” says Scott Stolz, senior vice president of private client group investment products at Raymond James and an expert on annuities. “The stock market is too volatile and interest rates are too low, so the money is not there to support an insurance company making the higher payouts on new contracts. For the last four or five years, insurance companies have been cutting back on these guaranteed riders.”
Insurance companies didn’t make the money they thought they would on contracts written before the financial crisis, and some wrote too many policies with generous riders, experts say. Several were forced to take TARP money during the financial crisis to maintain their solvency. “You are not going to get 6% and 7% payments a year with cost-of-living increases anymore,” says Kimberly Foss, president of Empyrion Wealth Management in Roseville, Calif., who specializes in retirement planning. “Now you are lucky to get 3% or 4%.”
Despite the reduction in benefits, variable annuity net sales for 2012’s third quarter increased 44.3% to $5.8 billion, from $4 billion during the second quarter, according to the Insured Retirement Institute. Total sales, which take into account values on annuities that are surrendered or exchanged or traded in other ways, dipped 4.9% to $36.3 billion from the second quarter.
“The significant improvement in net sales indicates the third-quarter drop in gross sales may be a function of reduced exchange activity rather than a slowing of new investment,” says Frank O’Connor, a product manager at the Morningstar Annuity Research Center. “The lion’s share of positive cash flow is concentrated in variable annuities offering income guarantees, which reflects continued demand for these types of products among investors in or near retirement.”
Despite the continued interest from consumers, some insurance companies are trying to pull out of the business. Hartford Financial Services Group Inc., based in Hartford, Conn., announced this fall it is offering buyouts to its variable annuity holders to terminate their contracts and will stop selling annuities to individuals. Axa SA’s Axa Equitable and Aegon NV’s Transamerica have been offering similar deals.
Whether it is a good idea for a policyholder to take these buyouts is debatable. Peter Maris, a principal at Resource Financial Group in Wilmette, Ill., says consumers should see a red flag whenever insurance companies offer these deals. “In general, I tell my clients not to take the buyout because they will not be able to get anything comparable issued from another company,” Maris says.
Others say it is difficult for an advisor to know what to tell a client because there are too many unknown variables, says Moshe Milevsky, a professor of finance at York University in Toronto who studies annuities. If a person is expecting a long life span, he or she would want to keep the annuity, Milevsky says.
But Eric Henderson, the senior vice president and leader of the individual products and solutions segment at Nationwide Financial, says a variable annuity holder might need the money for some emergency or pressing need that would make it a good idea to take the buyout. However, Nationwide is not one of those companies getting out of the variable annuity business. The company is strongly committed to the market, Henderson says.
“We are relatively conservative and we did not write too many variable annuity contracts prior to 2008, when the market was going strong and some companies were writing too many contracts with lucrative benefits. Plus, we hedged our contracts better than a lot of companies, so we had protection when the market declined,” Henderson adds.
A hedge is bought from an outside company as protection in case the market declines and will no longer support the payout required by the variable annuity contract.
Nationwide does its hedging calculations in-house instead of outsourcing them and feels it does a better job at it than others, which has allowed it to stay in the variable annuity market, Henderson says. The company sold $7.6 billion in variable annuities in 2011 and had sold $3.37 billion in 2012 as of September 30. Sales are down this year, which the company anticipated, because Nationwide reduced some of its benefit riders, Henderson says.
Regardless of the challenges, variable annuities are going to remain part of the investment mix, say experts. “It’s all relative,” says Christine A. Costello, a licensed agent for New York Life Insurance Company. “Payouts do not have to be exorbitant to look good in this low interest environment. The current situation does not spell doom and gloom for the variable annuity market.”
Bruised, But Not Broken
January 2013
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