David Blanchett, head of retirement research at Morningstar Investment Management, has watched the popularity of variable annuities ebb and flow over the past two decades. The 2008 market collapse and recession helped make variable annuities' guaranteed income more desirable, and he contends there is often a place for such products within a financial plan.
Mr. Blanchett challenges advisers to match these complex investments with appropriate clients. He also highlights one venue that offers consumers both a better deal and better policy options — through a 401(k).
InvestmentNews: What shape is the variable annuity business in as we start 2013?
Mr. Blanchett: It's definitely changing. We've come from a place six or seven years ago, where benefits were very rich, perhaps underpriced. As we've moved through the Great Recession with low interest rates and other considerations, we've seen the attributes within variable annuities change. In many ways, they are less favorable, and because of some of these pricing considerations, we're seeing more and more insurance companies exit the market. Some are entering the market with innovative products, but for the most part, especially in terms of the living-benefit portion of variable annuities, there's been a dramatic shift in the companies still offering those benefits for investors.
InvestmentNews: Are all variable annuities similar?
Mr. Blanchett: Through time, we've seen an increase in the complexity of the benefits and features of variable annuities. They used to all be immediate fixed annuities where you gave an insurance company or a government a lump sum and they guaranteed you income for life. As we've moved through time, especially the past 10 or 20 years, an array of complexity has been added, especially in the investments within annuity contracts. Now you see different types of living-benefit riders, different investments and different portfolios.
There's also been somewhat of a shift in some variable annuity accounts to managed-risk investments that target an even level of risk. They change the asset allocation accordingly. The product suites and the investments available have increased in complexity, and I think they will continue to do so. Different investors seek different types of guaranteed income, and insurance companies are responding to that desire by creating different flavors and different products.
InvestmentNews: When do variable annuities make sense for clients and what features should advisers examine to find the best ones?
Mr. Blanchett: They can make sense for clients at any age. They make the most sense for clients who are near or in retirement. As for features, the obvious starting point is cost. Then there is the investment quality. What are the investment options available?
Then you think of deaccumulation — once you've paid for the annuity, what are the payout rates and payout options? Look at the costs of the different features.
InvestmentNews: What's the biggest challenge in selling variable annuities to clients?
Mr. Blanchett: These are very complex products, and those individuals who have sold them aren't always fiduciaries, so in the past, there hasn't been a focus on using variable annuities as part of a financial plan. In many circles, they are kind of frowned upon. But there's definitely a place for these products inside a financial plan. Where I see the market working for financial advisers is in conjunction with everything else — taking a holistic approach to creating the best retirement income plan for clients. Not all a client's assets are going to be in an annuity, but these are a type of product that deserves consideration for most retirees.
InvestmentNews: Is the biggest selling point the guaranteed income?
Mr. Blanchett: Yes, right now, it's more valuable than ever. People think of guaranteed income and they think about bonds. Go out and buy government bonds and you are going to earn 2% on your investment for the next 10 years if you hold them to maturity. That's a very low return, and it's very hard to achieve a high withdrawal from a portfolio when you are only earning 2% per year, which can mean a negative real return after thinking about inflation.
InvestmentNews: Is there anything new expected from the annuity industry in 2013 and beyond?
Mr. Blanchett: One thing that I am excited about is the increasing adoption and usage of these products in 401(k) plans. One reason I like it is, these products have incredibly favorable pricing. I would call it almost institutional pricing, where the cost of owning a variable annuity in the 401(k) environment is lower than if you go out and purchase one yourself. The options in retirement plans are better than the average variable annuity being sold today. So giving someone in a 401(k) plan access to a high-quality variable annuity is definitely an improvement over the current way, which is: If you want one, you usually contact an insurance agent, who doesn't always have your best interest at heart.
InvestmentNews: Do many retirement plans offer variable annuities today?
Mr. Blanchett: We know it is a minority, but it is increasing. The vast majority of products today don't have them, and there's a whole host of reasons. These are complex products. There are portability issues, there are state licensing issues. But we are talking to more employers about offering them in 401(k)s, and we know that they'll become increasingly popular. I don't by any means think they'll become the most important investment in 401(k)s now or ever, but I think they will give older investors in 401(k) plans access to a high-quality [investment] if they want to use it.
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