Advisers find slim pickings as VA market contracts

Financial advisers, reeling from last year’s tumult in the variable annuity market, are now rethinking the carriers they use and the strategies they put together for clients.

The herd of variable annuity providers has thinned in the past year, with Genworth Financial Inc. and Sun Life Financial Inc. exiting the industry, and John Hancock Life Insurance Co. restricting its annuity distribution to a handful of broker-dealers.

Meanwhile, Prudential Financial Inc. and MetLife Inc. have tweaked their living benefits to reflect the realities of market volatility, rock-bottom interest rates and the cost of hedging those risks.

Most recently, some carriers have been controlling their VA and living-benefits exposure by limiting fresh inflows into products that already have been purchased.

The moves allow carriers “to make sure they don’t leave the door open for someone to access the prior generation of products,” said Ken Mungan, a consulting actuary with Milliman Inc.

For example, Ameri-prise Financial Inc. re-cently filed with the Securities and Exchange Commission to limit additional purchase payments after today into -certain RiverSource VA -contracts that utilize the SecureSource Stages 2 guaranteed-lifetime-withdrawal benefit. That feature locked in market gains, credited 6% increases to clients’ benefit base and allowed withdrawals of as high as 7%, depending on the client’s age.

CONTRIBUTION RESTRICTIONS

Axa Equitable Life Insurance Co. and MetLife also put in place contribution restrictions for certain already purchased VAs with living benefits.

These days, slimmer pickings are forcing advisers to look at carriers they would have otherwise ignored and to reduce their own — and their clients’ — expectations for the benefits these lower withdrawal and growth rates will have for clients’ retirement outcomes. Some advisers are even weighing the use of alternatives to variable annuities, attempting to protect principal through structured notes and seeking growth through other investments.

For instance, Mark Cortazzo, senior partner at Macro Consulting Group LLC, has been using a portfolio of investments alongside longevity insurance or a deeply deferred annuity. The portfolio needs to last only until the client is a certain age, when the longevity insurance kicks in.

“There’s no substituting the VA, but you need to look for dividend-paying stocks and larger allocations to alternative assets that aren’t going to operate the same way as equities,” said Bruce Cacho-Negrete, an adviser with Raymond James & Associates Inc.

Thorough research might un-cover master limited partnerships that offer tax-advantaged yields of at least 6%. They’re especially worth a look now that carriers have cut income and growth benefits to 5% — down from the 7% of pre-recession days — and many VAs now call for high bond allocations, he added.

“I just don’t want a 5% income guarantee on something that’s 50% bonds,” Mr. Cacho-Negrete said. “The likelihood of needing the insurance becomes so small; it’s no longer worth it.”

Since equity market volatility and low interest rates drive the cost of hedging, these two issues have been the biggest contributors to insurers’ decision to cut the array of investments customers can choose from, and to reduce living benefits.

A MUST HAVE

Access to a broad array of investments is a must-have for some advisers, who feel the chief benefit of a VA is the opportunity to lock in strong market gains and give clients the highest income base achievable.

Lately, however, some insurers are limiting risk and return by imposing dynamic asset allocation programs that will move clients’ funds to fixed-income investments during periods of high volatility.

Meanwhile, others are adding self-hedging portfolios as underlying investments. ValMark Advisers Inc. uses exchange-traded funds, futures contracts and put options as a way to hedge within the VA subaccount, thus dampening market volatility.

Such “protected” strategies are in place at Ohio National Life Insurance Co. and will be added to Lincoln National Corp.’s VAs this year for customers seeking higher levels of guaranteed income, Lincoln executives said during a fourth-quarter conference call.

In reaction to insurers’ imposing dynamic asset allocation programs that move clients’ funds to fixed-income investments, some advisers are using lower-profile VA providers that permit higher equity allocations.

Guardian Life Insurance Co., for instance, has an asset allocation model that allows an 80% investment in equities. Ohio National permits up to 70% allocations into equity portfolios.

“Ohio National hasn’t dialed back like other carriers by using algorithmic asset transfer programs,” said David Provinsal, a managing partner at Paradigm Wealth Management LLC. MetLife is being “re-evaluated” by Paradigm in light of changes to its income benefits, he added.

Craig Byrd, president of Byrd Financial Group, said he recently sold annuities from SunAmerica Annuity and Life Assurance Co., which has just added a new income option for lifetime 5.25% withdrawals, starting at 65. Purchasers preferred to be invested aggressively in the VA, he said.

A NEW REALITY

To some extent, the steady march toward lower benefits and stringent investment requirements has made financial advisers and clients confront the reality of what they can hope to achieve with variable annuities.

“[In the past], 5% was the benchmark for withdrawal benefits for 65-year-old clients, but we’re seeing some firms go below 5%,” said John McCarthy, product manager of adviser software and annuity solutions at Morningstar Inc.

For advisers, giving clients a reality check about today’s VAs versus the older products has become a regular part of the conversation.

“We get a lot of referrals where someone might say their friend has this great annuity, and ask whether they can get the same one,” said Kevin Van Dyke, president of Bloomfield Hills Financial.

In many cases, those “great” annuities are no longer available.

Clients have to manage their expectations, Mr. Van Dyke said.

“Nowadays, your benefit may be 5%, but the funds are so conservative that you shouldn’t expect to make 20% if the market goes up that much,” he said.

The latest contribution changes also have thrown a monkey wrench into some financial plans.

“Contribution limits have changed the way we’re looking at these VAs,” Mr. Cortazzo said. “Some of the clients we’ve set this up for would have an initial rollover [to fund the VA], but then a year or two out, they expected to add some more money.”

Nevertheless, many advisers agree that having some portfolio protection is better than none at all.

“We’re not in Kansas anymore,” said Susan Moore, president and founder of Moore Wealth Management.

“To have that safety net around you, especially when you have this zero interest rate for a few more years, a 4.5% benefit is a lot better than 1% or 2%,” she said.

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